VR Logo

Trade your way to poverty

A new generation of equity-trading platforms is amplifying the worst kind of investor behaviour

Trade your way to poverty

Some researchers from two US universities have discovered that whenever the Robinhood app had technical problems, stock volatility decreased. Not just that, by a whole lot of other measures, the average 'quality' of trading went up. For those who have heard of Robinhood and the GameStop saga, this study was done months before that, in mid-2020 in fact, so it had nothing to do with GameStop. For those who haven't heard of Robinhood, it's a discount broker in the US that offers trades in stocks and ETFs at zero commission through its mobile app.

The GameStop story is now too complicated to narrate here but you can go to bitly.com/hoodgame to read all about it. However, what it has demonstrated beyond any doubt is that a platform which collects a large number of new and minimally mature traders can have some very odd effects on equity markets. The study I have quoted above was conducted by researchers from Oklahoma State University and Emory University. They identified periods when the Robinhood platform had glitches and studied how trading patterns changed during these times. They found that stocks held by many Robinhood investors had fewer trades and less price volatility when users of the app were unable to trade.

The study says that "... the findings support the view that the popularity of zero-commission brokers has attracted a new type of uninformed equity-market participant that in aggregate has negative effects on market quality." Not just that, the study also quantifies the kind of questions that traders ask on internet forums which are frequented by this new generation of investors and finds that the very basics of markets are not understood by many.

A study like this obviously starts with many pre-formed biases and therefore cannot be taken as the unvarnished truth but there is nothing surprising in its findings. In India too, this issue is now clearly recognised and has in fact attracted regulatory action. Last year in July, SEBI announced a new set of measures which eventually eliminated margin trading in the cash segment of the equity markets. The regulator did this in response to a huge boom in equities trading by retail investors, especially new investors but older ones too. Just before that, in an interview with a newspaper, the SEBI Chairman had expressed alarm at this boom in retail investors' activity on the equity markets.

It's hard to take a balanced view on this entire issue. Everyone has a right to trade in the markets and there is no better way to gain experience than making mistakes. In fact, I've read the founder of Zerodha, which is roughly India's equivalent of Robinhood, say that he lost money repeatedly as a trader and before he started in the brokerage business. There's more than a little irony here but that's the way the business works.

However, preventing investors from excessive margin trading is also a valid regulatory goal. Since discount brokerages make a good chunk of their money from financing such trades, they have every incentive to lure traders as deeply into this activity.

The bottom line is that social media and app platforms are amplifying every trend to a previously unimagined degree. As the GameStop story showed, on the internet, you can gather a mob of millions of retail traders, and each can do a small trade which they can afford to risk losing but which can together blow away a large institutional investor or cause some other kind of a fracture in the market. Nothing illegal may be happening here and in any case, the legacy regulatory structure in any market is not designed to counter this and even if they wanted, I doubt if they can do anything to counter it.

However, that's not the worst of it. The worst aspect is that this huge crowd of new investors is getting an entirely delusional idea of what equity investing is. Instead of realising it to be an activity that essentially consists of identifying good companies and then investing in them for years, their entire idea is that of punting. This was always there but the new generation of app-based platforms is making it worse.

The net effect is the exact opposite of what the name Robin Hood implies.