Who Is on the Other Side of Your Trade?

Every investor has rehearsed the reasons they bought something. Very few have ever asked the obvious follow-up: at that exact price, at that exact moment, someone sold it to them, and they were glad to. Both parties looked at the same screen, the same price, very often the same public filings — and reached opposite conclusions decisively enough to act.

That is not a paradox. It is the mechanism. A market does not clear because everyone agrees on value; it clears because people disagree about value, agree about price, and have different reasons for needing to transact. Market structure is the discipline of taking that seriously — asking not what is this worth, but who is willing, and why, and what does their willingness cost me.

Reduce the population of possible sellers and you get three broad types. Almost every execution outcome you will ever experience is explained by which of them you met.

The important observation is that only the third one is genuinely costly, and it is the only one most retail commentary never mentions. Spreads and fees are visible, small and endlessly discussed. Adverse selection — systematically trading against people who know more than you — is invisible, larger, and shows up only as a vague sense that your fills are never quite good.

It is tempting to think of a market maker as a sophisticated investor with a strong view. They are not. A liquidity provider quoting both sides of a stock is expressing no view on the company at all. They are running a very specific business: selling immediacy.

You want to own something now rather than in three days. Someone has to hold the other side of that position in the meantime, and carry the risk that the price moves while they are holding it. The spread is the fee for that service. It is genuinely a service, and it is genuinely worth paying — when you need it.

In microstructure terms, almost every long-term individual investor is uninformed flow. This sounds like an insult. It is a technical description, and it is close to the ideal state for someone investing over decades.

Informed flow has an edge, and pays enormous fixed costs to keep it: research infrastructure, data, personnel, and the constant risk that the edge decays. Uninformed flow has no edge and needs none, because it is not trying to extract value from other participants. It is trying to own productive assets for a long time and let the assets do the work.

The mistake is not being uninformed. The mistake is behaving like informed flow while being uninformed — trading frequently, urgently, and on public narrative, which means repeatedly paying for immediacy you do not need in order to take the other side of people who do have an edge.

1. 1

   Trade rarely

   Every avoided trade is a spread not paid and an adverse-selection lottery not entered. The cheapest execution in the world is the order you did not send.

2. 2

   Trade patiently when you do trade

   A limit order says: I will supply liquidity rather than demand it. You give up certainty of execution and, in exchange, stop paying the immediacy fee. For an investor with a multi-year horizon, that is an obviously good trade.

3. 3

   Avoid the moments when everyone is informed

   The open, the close, results day, index-rebalance day. These are the windows in which the proportion of informed flow is highest and spreads are widest. Nothing about a ten-year holding requires it to be bought in the first nine minutes of a session.

4. 4

   Size to the book, not to your conviction

   A position that takes several days of normal volume to build takes several days of normal volume to exit — and the day you want to exit is precisely the day that volume will not be there.

The single most expensive assumption in investing is that liquidity is an attribute of a security. It is not. It is a description of the current willingness of other people to take the other side, and that willingness is correlated across the entire market — it evaporates exactly when it is most needed.

An asset is not liquid. An asset is liquid in calm conditions, at small size, when nothing is wrong. Those are three separate conditions, and a stress event removes all three simultaneously. This is why the phrase 'I can always get out' is the most reliable warning sign in a risk conversation: the ability to exit is being treated as a property of the holding rather than a property of the market's mood.

Take market structure seriously and a number of things that look like separate pieces of advice collapse into one idea.

• —Low turnover is not a virtue of temperament. It is the direct consequence of understanding that every trade is an invitation to be adversely selected.
• —Index funds are not cheap only because of their fee. They are cheap because they are structurally patient, and patience is the thing that is actually being priced.
• —Illiquidity premiums are real, but they are compensation for a genuine constraint, not free money. If you could not have held through the constraint, you were never entitled to the premium.
• —'The market is rigged against retail' is usually a misdiagnosis of an avoidable, self-imposed cost. The structural disadvantage is small. The behavioural one is enormous.

You cannot make yourself informed flow. You can, at essentially zero cost, stop volunteering to trade against it. That single adjustment is worth more to most portfolios than any security-selection decision they will make this year — and unlike security selection, it works every time.