The conventional thinking on Wall Street had been that traders who buy and sell so-called odd lots -- less than 100 shares of a stock -- were small investors not worthy of much regulatory attention.
It turns out that was not entirely accurate.
Using Pittsburgh Supercomputing Center's powerful Blacklight computer, researchers have uncovered data that shows an alarming pattern in which some of the largest and most sophisticated traders have been systematically buying and selling shares of stock in odd lots in order to stay beneath the radar and avoid having their trades be noticed by securities regulators or other traders.
The findings have led the New York Stock Exchange, the Nasdaq stock exchange and the Financial Industry Regulatory Authority to redefine how the securities industry tracks small stock trades. Previously, odd-lot transactions did not have to be reported to regulators. But new rules that go into effect in October will require that all trades be reported.
"The Supercomputing Center has played a role in this important decision," said Ralph Roskies, scientific director at the Supercomputing Center in Oakland.
Researchers Mao Ye and Chen Yao of the University of Illinois Urbana-Champaign and Maureen O'Hara from Cornell University used the Supercomputing Center for their research on odd-lot trading that took place on the Nasdaq stock exchange.
They found that with the emergence of high-priced stocks such as Google ($904 a share) where trading a round lot requires an investment of $900,000 or more, odd lots make up a significant fraction of the trades and should be included in the official record of data that is reported in the Trade and Quote Database, which is used to study asset prices, trading and investor behavior.
"For every 100 trades of Google, 52 to 53 of them are in the form of odd lots," Mr. Ye said. "There are more missing trades than trades you can see. In terms of volume, more than 20 percent of the trading volume [among all stocks] is missing" in the official count.
"In the U.S., they care a lot about transparency of the market," he said. "The new rule change will remove a kind of darkness we cannot see that we never realized was there."
Nasdaq officials worked closely with the researchers by allowing them to compute trading data on a special set of 120 stocks from 2008 to 2009 and for a one-week period in February 2010. They found the exclusion of odd-lot trades resulted in a median 19 percent of missing trades per stock, but for some stocks the missing trades were as high as 66 percent of total transactions.
"Nasdaq is pleased to have supported the university research that led to odd-lot trades being shown to the public," said Frank Hatheway, chief economist at Nasdaq. "We strongly believe in transparency and in research to make the markets better. Allowing investors to see trades of all sizes, not just big trades, helps everyone know how much their stocks are worth and even lets people see their own trades go by on the ticker."
Hedge fund manager Timothy Skyes said there is a reason why traders have exploited the odd-lot system to camouflage their moves.
"Traders, especially big and successful ones, don't want other people knowing their trades," said Mr. Sykes, author of "An American Hedge Fund" and CEO of Millionaire Media, based in Miami.
"They don't want to give away their secrets or show their hand as Wall Street is very competitive and other traders attack when they smell blood," he said. "So for example, if a big trader is known to have a large position in a stock that is tanking and other traders know this trader's hedge fund is in trouble, they will smell the blood and short sell the stock to make this trader's loss grow, thus forcing him to sell more sooner, thus forcing the stock down and profiting from this one trader's demise.
"Or, if everyone knows a trader is short a stock that is doing well after let's say the company reports great earnings, they will buy the stock just to create a short squeeze to force this trader to buy to cover his position and thus pressure the stock, unnaturally, higher and reaping the rewards," Mr. Sykes said.
"Transparency is the future of finance so anyone who tries to hide from it will go the way of dinosaurs."
Tim Grant: email@example.com or 412-263-1591.