There has been quite a buzz in the financial press about the rise of retail investors, particularly, Robinhood. In case you have no idea, Robinhood is day trading for the Tinder generation. It is a somewhat small retail brokerage that allows you to use features such as “swipe up” to buy stocks, options, and even crypto. The app has a sleek UI and users take the risk of making rash decisions easily. Tinder for the stock market. 

Investing for everyone

Robinhood, based in Menlo Park, California, started in 2013 and quickly became the most popular in a wave of apps that have surged trying to redefine the world of personal finance for the smartphone era. The fact that the app can be installed on smartphones enables people to trade anywhere and anytime; thus, people are less restricted in what concerns stock trading. The benefits of a less restricted method are that it opens up a lot of possibilities and changes the way stock trades are carried out. Perhaps, the most important, is that it tears down barriers to entry of the markets by providing a free platform (or relatively at least) and it is opening the door to the world that used to be protected and guarded by the elites. 

Nonetheless, it is unknowingly letting in young and inexperienced people into an environment so enticing and interesting yet unforgiving and dangerous. Rather than directing users to adopt a coherent strategy, it pushes riskier options like individual stocks and cryptocurrencies. It even provides trading products such as futures and options, both of which are used by advanced professionals that carry extreme risk. 

Encouraging day trading?

While the app prides itself on democratizing America´s financial system, by not charging commissions on trades, it seems to take advantage of several tricks to spur user engagement. As a consequence, it is generating a new breed of day traders who celebrate and develop risky habits that might be costly over time. 

The appearance of the numbers rising or falling and even confetti bursting does matter since it can effectively nudge the user toward long term success to a potentially dangerous habit or speculation. 

When you go on a dating app like Tinder, it is not very likely to find a long term commitment. It might result in a fling or a short term dating prospect (or several). Similarly, the Robinhood app is set up to include, on its front page, tickers for crypto and quotes for stocks with high volatility, while exchange-traded funds are difficult to find. As the design affects the behavior of Robinhood customers encouraging day traders, the app seems to be failing in educating its users about investment strategies. 

Skill vs Luck

As some day traders do great, while some others do very bad. In his book “Fooled by Randomness”, author N.N. Taleb calls the ones that do very well “lucky fools”. He also reveals how randomness can become especially dangerous in trading and investing in the financial markets as someone begins to ignore the inevitable risk that is always present by believing that success in the markets now is a reflection of what will continue to occur.

An example is Dave Portnoy, an internet celebrity who has posted daily videos about his profits from the rally to his 1.5M followers on twitter. Portnoy often talks about the stocks he’s trading. He even claimed to have “killed” Warren Buffet after the recent stock rally to a near all-time high amidst a global pandemic. Some (serious) Chinese media even took this seriously

Failure to recognize risks may lead to a possible blow at the end of the trend. While the skillful may be unfortunate sometimes due to the random variance of odds, and the inexperienced may be lucky in the short term, the reality of skill vs luck begins to become more evident in statistical performance over the long term with sufficient data.

Decision making should be based on all the information you have up to a certain point in time, hindsight is never available in real-time. The earlier you realize as to what matters and what doesn´t, the better filter you will have for randomness, and the more clear you can see the real patterns that create an edge in decision making. 

Both risks and rewards are embedded in randomness. The best way to manage an unknown future profitably is creating asymmetric risk/reward ratios. If you are wrong you lose a little and if you are right you make many times your risk. 

Instant world

Like Tinder, Robinhood users can make instant transactions as easy as a “swipe-up”. The outcome of this speedy transaction is the rise in the number of trades executed. As market changes take place, investors (now more than ever) need to react as quickly as possible. 

Similarly, quick reactions to the new information mean that the markets keep changing faster than ever. The impact that online trading has on the stock market volatility increase is still unclear. But what is clear is that enabling access to all into the stock market is leading to a tinder-like phenomenon in the financial world.  

The US equities market is already behaving in a super bizarre manner this year, with the Fed as a force that often took many professional investors by surprise. The addition of Robinhood traders adds another layer of complication – in the absence of Vegas, many find this exciting. 

 

Thanks for reading The Low Down (TLD), the blog by the team at Momentum Works. Got a different perspective or have a burning opinion to share? Let us know at hello@mworks.asia.