Which Trades Move Stock Prices in the Internet Age?

Abstract

We reexamine the stealth trading hypothesis that privately informed trades concentrate their trades in medium sizes (cp. Barclay and Warner (1993) using a comprehensive transaction data set covering all Nasdaq stocks for the period from 1993 to 2003. While we find support for the hypothesis and prior empirical work in the first third of the sample period, we also document a dramatic shift of the distribution of informed trades away from medium-sized and into small-sized trades beginning around 1997, and find that since in the recent past about 70-85% of price discovery takes place via small trades. Our findings are robust with respect to the choice of methodology, i.e. weighted price contribution, information share and common factor weights. We explore two main explanations for this phenomenon, namely a) that major advances in information technology have vastly improved individual investors' access to financial information and their ability to participate in the trading process speedily and cheaply, leading to a leveling of the 'playing field' between individual and institutional traders, and b) that regulatory action such as the reduction in tick size and the introduction of the Order Handling Rules on Nasdaq with the ensuing growth in alternative trading systems have caused this change. We find much support for the second alternative, but also present some evidence in favor of the first, and how small traders may have contributed to the dramatic rise and fall of Nasdaq.