By Pam Martens and Russ Martens: March 24, 2021 ~
There’s a full-blown assault occurring right now to lure young, unsophisticated investors to trade their own accounts instead of investing in low-cost passive index funds or using an investment advisor.
The enticements are the worst we have ever seen and harken back to what was occurring in the lead up to the devastating 1929 stock market crash that ushered in the Great Depression.
Consider the video advertisement shown below from stock and options trading app, Gatsby, owned by Gatsby Digital, Inc. A young black man sits unshaven in his bathrobe tapping on his mobile phone, ostensibly getting stock quotes or placing trades. A voice-over reassures him: “Of course you’re ready. You were born ready. And with Gatsby, it’s so easy. You can do it from anywhere.” Fade to the man in the bathrobe sitting on a toilet seat, ostensibly still trading his account.
On top of that type of seduction, the trading app informs customers on its website that “Gatsby allows users to earn rewards points with every trade. Customers can then redeem their rewards for gift cards at top retailers.”
According to the self-regulator, FINRA, Gatsby uses the name ViewTrade Securities, Inc. for its broker-dealer, which is based in Boca Raton, Florida, 1200 miles from Wall Street. Like the Robinhood trading app, Gatsby offers commission-free trading, then ViewTrade Securities sells its customer orders in exchange for payment-for-order-flow to high-frequency trading hedge funds that also have an affiliated market-making firm. Also, like Robinhood, one of the market-makers that ViewTrade is selling its orders to is Citadel Securities. The other major trading firms paying ViewTrade for stock order flow are Two Sigma Securities, Virtu Financial, and UBS Securities (part of the giant global bank).
As congressional hearings have recently suggested, these trading apps appear to be enticing the so-called “dumb money” from retail investors so that high-frequently traders can capture an ever-bigger share of the bid-ask spread.
There is no shortage of academic studies that have conclusively found that retail investors attempting to trade their own account lose money, and do so consistently.
A 2011 study by Brad M. Barber of the University of California, Davis and Terrance Odean, Haas School of Business, University of California, Berkeley concluded as follows:
“This research documents that individual investors (1) underperform standard benchmarks (e.g., a low cost index fund), (2) sell winning investments while holding losing investments (the ‘disposition effect’), (3) are heavily influenced by limited attention and past return performance in their purchase decisions, (4) engage in naïve reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviors that generated pain, and (4) tend to hold undiversified stock portfolios. These behaviors deleteriously affect the financial well being of individual investors.”
In a more recent study, released in October of last year, Barber and Odean joined with Xing Huang of the Olin Business School at Washington University in St. Louis and Christopher Schwarz of the University of California at Irvine to assess Attention Induced Trading and Returns: Evidence from Robinhood Users. They summarized their findings as follows:
“We study the influence of financial innovation by fintech brokerages on individual investors’ trading and stock prices. Using data from Robinhood, we find that Robinhood investors engage in more attention-induced trading than other retail investors, and Robinhood outages disproportionately reduce trading in high-attention stocks. The evidence is consistent with Robinhood attracting relatively inexperienced investors. However, we show that it can also be partially driven by the app’s unique features. Consistent with models of attention-induced trading, intense buying by Robinhood users forecast negative returns. Average 20-day abnormal returns are -4.7% (-19.6%) for the top stocks purchased each day (extreme herding events).”
At a February 18 House Financial Services Committee hearing, Congresswoman Cindy Axne of Iowa questioned Robinhood CEO, Vlad Tenev, on the behavior inducing aspects of his trading app. The exchange went as follows:
Axne: “Right now, what I’m seeing is gambling in the stock market and that’s not a real solution to income inequality and I don’t think we should pretend that it is.
“Just last June when Hertz declared bankruptcy, after that Robinhood was actively pushing the stock on its site, it was trending on Robinhood, and the promotion of that worthless stock I don’t think is good for investors. That’s a gamble that they shouldn’t have taken. That’s just one example…
“Generally, 99 percent of short-term traders underperform the market. So, Mr. Tenev, you say Robinhood’s mission is to democratize finance. Is that correct?”
Tenev: “That’s correct Congresswoman, yes.”
Axne: “Okay. So I want to ask you then, you’ve invested significantly in behavioral research. And just so you know, I own a digital design firm with my husband so I’m familiar with what behavioral research can do for platforms and websites. That behavioral research has really shaped how your app is designed, is that correct?”
Tenev: “Congresswoman, like many technology companies we employ data scientists, user researchers, and designers to provide a better customer experience.”
Axne: “So on the specifics, when people sign up they get a scratch-off ticket to see what they get; confetti falls every time they place an order; they get push notifications; they’re encouraged to trade; if a friend signs up they get a free stock. On and on. Why have you added specific gaming design elements to look like gambling to your app that encourages more frequent trading?”
Tenev: “Congresswoman, as I mentioned earlier, we want to get people what they want in a responsible, accessible way. We don’t believe in gamification. We know investing is serious and that’s why most of our customers are buy and hold. A very small percentage of our customers utilize margin.”
Axne: “I appreciate that but you know, folks like my nephew actually aren’t your customer. They’re your product. Your customer is sitting right next to you, Mr. Griffin with Citadel.”
Since the stock trade being made on the Gatsby app by the guy on the toilet seat is also going to end up being executed at billionaire Ken Griffin’s Citadel Securities, or another high frequency trading firm, once again it would appear that the toilet trader is the product being sold to the real customer, a high-frequency trading firm.