Research - 08.02.2021 - 00:00 

Trading apps lead to risky investment behaviour

The recent events surrounding the speculation in GameStop shares on the stock exchange clearly show that small-scale securities trading is undergoing radical changes. New online platforms and trading apps offer low-cost, direct access to the financial markets for everyone. However, their providers are often criticised for enticing their users to take increased financial risks. A new study now supports these allegations.

8 February 2021. What was once a time-consuming process that had to be carried out by a banking specialist can now be done very easily with just a few clicks on a computer or smartphone. Trading in shares and other securities via trading apps or online platforms such as those of Swissquote or Saxo Bank is becoming increasingly popular. At the start of the corona pandemic in March 2020 alone, more than five times the number of accounts were opened with the two providers than in the same period of the previous year. In addition, new online brokers (often emanating from the US) are gaining a foothold in Europe: Robinhood, for example, already has more than 13 million active users. Several factors are making these online services so successful: investors can use them to invest even small amounts in various markets. In addition, digital securities trading is relatively inexpensive, can be carried out around the clock, and the associated trading apps are extremely user-friendly.

Just like gambling

However, these platforms are facing growing criticism. This is because they make it easier for new customer segments such as young adults or people with limited financial means and investment experience to start trading on stock markets. In addition, trading on the apps is often presented like a game of chance. With Robinhood, for example, all it takes to buy a share is a swipe across the screen. Critics believe that this gambling-like platform design could tempt young investors to engage in risky transactions. In the US, Robinhood has already been accused of insufficiently protecting inexperienced investors in gambling-like bets.

Brokers earn on every transaction

The online brokers rely on a variety business models. Many charge a fee for each individual transaction. They therefore have a financial interest in ensuring that users trade as much as possible. “Portfolio restructuring can make sense for investors in certain situations. However, frequent trading does not bring them any added value on average, but even reduces their performance”, says Prof. Marc Arnold from the Institute of Accounting, Control and Auditing at the HSG (ACA-HSG), co-author of a study on the new online brokers. “With active trading, you may occasionally perform better than the market in some individual transactions, but then again worse in others. On average, these effects cancel each other out after a very short time. But the trading costs of users of an online platform increase with active trading due to the accumulated fees. While this increases the profits of the online brokers, it massively reduces the performance for the investors.” Another contentious point is the digital communication between the brokers and the investors via the trading apps. This is because they not only enable the providers to track the behaviour of the users precisely via cookies, but also to send them personalised messages or pop-ups. This enables online brokers to influence the investors’ trading behaviour to their own benefit.

Push messages lead investors to take more risk

The study carried out by Prof. Arnold of the ACA-HSG in collaboration with Prof. Matthias Pelster of the University of Paderborn and Prof. Marti Subrahmanyam of New York University now proves that the messages sent by the providers have a significant influence on the users’ trading behaviour. For their paper, the researchers analysed trading data from over 240,000 customers of an online broker over a period of around two years,  focusing on the provider’s digital communication with investors. According to the study, one intuitively obvious effect is that users trade many times more frequently after receiving a push message from the broker. Less obvious, but no less relevant, is the second important finding of the researchers: they were able to demonstrate that investors take a significantly higher risks after receiving a message. This is a finding that is likely to be relevant not only in social but also in economic policy terms: “One could argue that systemic risks increase when many people start to trade more risky.  However, this is only a hypothesis that requires further research”, says Prof. Arnold. However, the socio-political implications of the study appear more pressing to him: “It is alarming if the customer group with limited financial means reached by online trading is tempted to take higher risks and thus to literally start gambling.”

Conflict of interest between providers and customers

The study’s findings regarding the increased risk appetite also seem explosive against the background that brokers often collect higher fees for riskier transactions. In addition, more speculative investments also tend to involve a higher trading rate, which increases the income of the providers even further through the fees accumulated in this way. “There is currently a blatant conflict of interest between online brokers and their clients”, says Prof. Arnold summarising the issue. “The online brokers want to maximise the trading fees they earn. To do so, they encourage investors to make frequent and risky trades, which in turn negatively affects their performance and risk profile.”  If this conflict of interest could be overcome, he sees great potential in online trading and digital interaction between providers and users. It is quite conceivable that personalised messages could be used to optimise the investment behaviour of individuals. “In principle, it would be easy for brokers to automatically measure and monitor the risk and diversification of each investor’s portfolio. If certain anomalies are observed, brokers could then send an alert to investors via SMS or pop-up, for example. Accounts could also be blocked if there are indications of gambling addiction.” However, to enable the potential of online trading to be used sensibly, a timely constructive debate on the opportunities, limits and risks of this development is needed.

Image: Adobe Stock / Oran Tantapakul

Discover our special topics