How Market Makers Profit From Your “Dumb Money” Trades

Wall Street’s market makers don’t just play the game. They play to win. And they win big.

But their advantage isn’t “dumb luck.” It’s a strategic move to bet against “dumb money” – the small trades made by everyday investors just like you. In today’s “Slap in the Face” Award, Steve McDonald explains why it’s time for us to wise up and stop being Wall Street’s fool.

Video Length: 00:02:30

Transcript:

The Department of Justice is investigating several large brokerages and clearing houses for violations of small investors’ rights.

I didn’t know we had any rights, but anyway…

It seems these brokers are collecting information about small investors’ trading activity and selling it to other brokers, who then use it to trade against the little guy.

What kind of information? The size of their trades and how many shares per trade.

And the smaller the trade, the more the information is worth. Trades of fewer than 500 shares are the most valuable. Here’s why:

Only small investors buy small positions – positions of fewer than 1,000 shares. You can look at the trading activity for any stock and know immediately whether it’s an institution or small investor, just by the size of the trades.

Years ago, this was called the “Odd Lot Theory.” An “odd lot,” back in the day, was any trade of fewer than 100 shares. If the number of odd lots increased, it was a sell sign. This is because odd lot traders were perceived as inexperienced and usually wrong.

Today, the little guy’s trading activity is simply called “dumb money.”

“Dumb money” because the pros know if it’s a small trade, it is coming from a small investor whose information is a hunch or an emotional reaction, and is always 180 degrees out of sync with what they should be doing.

And when the number of “dumb money” trades increases, a sell-off in the single stock or the broad market is not far behind.

The reverse is also true for selling.

This investigation of these brokerages and their “dumb money” dealings is a big, loud in-your-face confirmation of what I have been pounding the table about for years: If the little guy is buying in great numbers, you can be 100% certain it’s time to sell.

If he’s selling like the paper is on fire, it’s time to buy.

And perhaps the worst part of this whole insane situation lies in DALBAR’s recent discovery. This investment behavioral research firm has been collecting data about small investors’ behavior for 30 years. And it recently reported that, to date, no effort to change “dumb money” behavior has made a dent in it. In fact, it’s getting worse.

So I have two questions for you:

First, if this “dumb money” activity has been common knowledge for at least 30 years, how exactly is it a violation of anyone’s rights to capitalize on it?

And, two, aren’t you tired of being Wall Street’s fool?

“Dumb money.” It is making a fortune for the sharks, and it is coming right out of your pockets. Believe it!