Online platforms and trading apps have revolutionised access to financial markets, making them simple, affordable and available to all. They have triggered a veritable equity boom, particularly among young retail investors. But there is growing criticism in the meantime. Professor Marc Arnold from the University of St. Gallen sheds light on the opportunities and risks presented by digital securities trading.
Equity trading via online banks and trading apps has exploded since the coronavirus pandemic: in 2023, the e-brokerage market in Europe alone was estimated at over EUR 5 billion. What is it that makes these new offerings so attractive?
They make trading easier and cheaper than ever before. This gives investors the opportunity to invest even just small amounts in different markets. In addition, digital securities trading is available around the clock, comparatively inexpensive and easily accessible thanks to user-friendly trading apps.
This has particularly got young people under 30 into trading. Deutsches Aktieninstitut is already talking about the “equity generation”. Do you think the democratisation and rejuvenation of securities trading is to be welcomed?
I essentially find it good that younger people on limited budgets are also actively thinking about their savings and using a range of asset classes to accumulate wealth and retirement provisions instead of putting all their money into a savings account – especially in view of the current interest rate situation and loss of purchasing power due to inflation. However, I am concerned about how many new online traders are going about investing their money.
Why is that?
Many of them are taking a lot of risks and only trading over the short term. Both can lead to significant losses. Studies show clearly that the more often you trade, the lower the returns. And what’s more, if you trade too frequently with small amounts, even low fees will quickly eat up your profits.
Can you give an example of how new investors are willing to take risks?
They prefer highly volatile equities and speculative investment instruments such as cryptocurrencies or derivatives. They are inspired by success stories spread on social media and hope to generate enormous profits. For many of them, trading is also likely to be a form of entertainment.
Trading as entertainment?
Exactly. It feels like being in a casino. And the more a stock fluctuates, the greater the thrill. That may be OK as long as you’re only using “play money”. But when inexperienced retail investors “invest” their limited financial resources in this way, it can easily lead to sobering financial consequences. In addition, the long-term effect of trading costs is often massively underestimated.
But are the transaction fees for these neo-brokers not historically low or in some cases even free of charge?
The pricing structure is not at all transparent and there are often hidden charges. And as I said before, even when the fees are low, if you trade too often, the fees will eat up your profits. Assuming the fees are only 0.1% of the volume and someone makes 100 trades per year, the costs will already amount to 10% of the annual trading volume. This means that after five years, half the capital invested will have been lost.
Critics such as the legendary investor Warren Buffet complain that neo-brokers are actively encouraging their customers to gamble. Are they right?
Yes, because there’s a blatant conflict of interest. The business model of many online brokers is based on their customers trading as often and as riskily as possible as they make money from every trade and frequently earn double: on the one hand from the trading fees paid by customers and on the other from reimbursements from the trading platforms to which they forward the orders. That’s why they use different methods to create incentives that encourage excessive trading.
How do such incentives work in practice?
They start with the design: many platforms rely on “gamefication”, that is to say on gambling-like features that motivate investors to trade more often. For example, a swipe across the screen is all it takes to buy some shares. If you make a good trade, you receive a reward in the form of money raining down on the screen and progress to the next level. In addition, AI-generated pop-up messages encourage trading – and do so extremely effectively.
How can AI influence investment behaviour?
The algorithms used by neo-brokers know precisely how and when someone trades. And they send out the right information at the right time to influence investor behaviour in their favour. We analysed the behaviour of more than 240 000 customers of an online broker in an international study and found that recipients of push notifications from the broker trade a lot more frequently. At the same time, these customers take significantly higher risks. Investors are therefore actively encouraged to engage in a type of gambling. This is worrying and also has socio-political consequences.
To what extent does this have consequences for society?
By the fact that society bears the costs of it. Young people are being enticed to gamble away their entire savings. In addition, gambling is highly addictive. The number of trading addicts is increasing sharply and more and more people are receiving treatment in clinics. In Switzerland, for example, this figure has doubled in the last five years. However, the image of online trading does not as yet appear to be affected and, unlike gambling, it is still considered to be reputable. There is therefore no protection for addicts.
Do we need more regulation?
I’m not a fan of regulation and consider the benefits to be minimal. This can be seen, for example, in sports betting. If you introduce more regulation in Switzerland, gamblers will simply switch to foreign providers. I would focus instead on transparency and information. People need to be aware of what they are doing and how to invest sensibly. There is enormous potential for online brokers themselves in this regard.
Can you give an example?
Brokers could use their extensive knowledge of the trading behaviour of their customers to actively help them to make better decisions. For example, automated feedback could alert them to any mistakes they are making at an early stage, warn them of excessive risks or reveal the first signs of trading addiction. However, as long as the aforementioned conflict of interest exists, this potential will not be used in the interests of investors: instead of warning them, they will be encouraged to make further trades.
How can investors protect themselves?
By using trustworthy providers backed by a reputable bank. And by simply deactivating all push notifications and pop-ups – neither the neo-broker nor AI can actually provide any additional information that is useful for trading. The financial markets are so competitive and fast that any such information is already reflected in the prices. If you wish to make money over the long term so you can continue to lead a financially self-determined life when you retire, you should select an investment strategy that suits your current age, your financial situation and your individual risk appetite. You should stick to this strategy consistently and not be misled.
Marc Arnold
Marc Arnold is Professor of Corporate Finance at the University of St. Gallen. His research interests include credit risks and derivatives and financial intermediaries. Together with Matthias Pelster and Marti Subrahmanyam, he investigated the impact of push messages on investor and risk behaviour in the study “Attention Triggers and Investors’ Risk Taking” (2022).
