Personal Finance & Money Asked on April 21, 2021
Background: I recently explained to an amateur trader (who happens to be a family member) about the basics of the bid-ask spread and how market makers make money from the spread. As an offhand remark, I mentioned that market making firms are probably the best traders, and mentioned Virtu Financial‘s disclosure of having only one losing day in 1,278 trading days between 2009-01-01 and 2014-02-28 (source: Form S-1/A, page 2). This made her visibly excited, and she asked me whether or not market making firms such as Citadel, Virtu, and Jane Street are publicly listed companies. Virtu Financial is publicly listed (NASDAQ: VIRT).
I have the feeling that I have done something irresponsible, as she is likely going to buy stock in Virtu Financial after this. She thinks: "if you can’t beat them, join them", and she wants to "invest in the best trader". I seem to have accidentally given her an irresponsible stock tip.
As you may know, market making is a risky business. How should I explain the risks to an amateur trader in a situation described above? (I am thinking of using the case of Knight Capital Group as a cautionary tale).
Forgive me if this is more of a personal interaction question than a personal finance question; this is the first stock tip I have ever given in my life, and I don’t know how I should explain the risks to a person who can only think of profits. It is just unfortunate that I know too many easily-excitable gambler-speculators who don’t know that they are gambling.
Just because you share your personal opinions or insights about a company that causes someone else to go and make a potentially reckless trade without doing their own homework is not something that should cause you angst.
I don't know you were actually giving someone a "stock tip" in this case - you pointed out what they could easily figure out on their own if they so choose.
I agree with your concern that your family member may not know enough of what they're doing to make trades on their own without more professional input, but the fact you explained why one group of companies might pose a better investment opportunity (in your opinion) than others doesn't constitute a "tip" per se. It is simply explaining the mechanics of the market and how some companies might more consistently benefit from market activity than others.
It wouldn't hurt to give your family member some advice that it's okay to be excited about the potential of something, but that shouldn't be a replacement for doing good old-fashioned homework of understanding the companies they're considering (such as reading news, financial highlights, understanding the industry the company works in, how it stacks up against its competitors, what are the forecasts from analysts, both for the company and the sector, and so on) before actually investing money into it. If they aren't willing to do that, or they don't know enough to figure out how to go about it, then maybe they should be advised to invest in a mutual fund or some other vehicle that takes part in the sector overall and is managed by professionals rather than trying to pick individual stocks themselves. That's about all you can do, and what they do from there is entirely up to them.
Correct answer by SRiverNet on April 21, 2021
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