Author of new study highlights risks and implications of trading apps' design on retail investors' behaviour
For devotees of behavioural finance and others who want to understand the rise of meme stocks and retail trading during 2021, the CFA Institute’s recent report titled “Fun and Games: Investment Gamification and Implications for Capital Markets” promises some interesting reading.
“There has been so much regulatory attention [on gamification] in the last couple of years,” Sivananth Ramachandran, director of Capital Markets Policy at the CFA Institute and author of the report, told Wealth Professional. “But also, I think if you start looking at any investment app today, I think you’ll see some form of gamification has been seeping in.”
The institute’s report on gamification draws significantly from its most recent Investor Trust Study, which polled around 3,500 retail investors across 15 market around the end of 2021. In the latest wave of the biennial survey, it asked questions around investors’ views of gamification and its impact on them.
The institute’s gamification report is also based on a comprehensive survey of research from academic journals, books, and other sources to look at the issue of gamification.
“In our report, we also included behavioural nudges under the umbrella of gamification,” Ramachandran says. “Strictly speaking, gamification only includes things like the design and user experience within investing apps. But in popular parlance, people tend to conflate gamification and behavioural nudges as one concept.”
As Ramachandran notes, many trading apps’ design elements were borrowed from the world of gambling. Canadians who have entered casinos would be well acquainted with the use of light, colour, animation, and sound to create a stimulating experience for customers. Similarly, today’s trading apps employ confetti, cash bell sound effects, and other stimuli to excite users into making trades.
Another potentially problematic element is the use of leaderboards, where traders are ranked based on very short-term performance – typically over the last month or over the past two years. Some trading apps allow their users to imitate the trades of the most highly-ranked traders, sometimes for a fee, through a practice called “copy trading.”
“In a financial market setting, where assets are volatile and it is extremely difficult to distinguish between luck and skill over short time periods, imitation could have stark implications,” the report said.
Ramachandran also highlighted investing apps’ use of notifications, whereby users are informed when a stock goes up or down by at least 5%. While users tend to sell stocks that had gone up by 5%, they tend to hold on to the stocks which went down by that amount.
“In investing parlance, that’s known as the disposition effect, which has a detrimental effect on long-term performance,” he says. “Overall, our report found that trading app features act on investors’ behavioural biases, which has an impact on them.”
Another recent report from the Ontario Securities Commission (OSC) reflects many of the same concerns highlighted by the CFA Institute study.
In a randomized controlled trial, the OSC put around 2,400 participants in a simulated investing environment with $10,000 of notional dollars. In that study, a portion of the participants were given points for buying and selling stocks. Another group was also shown a list of top traded stocks, which taps into the behavioural principles of salience and social norms.
While the points had no real value, the OSC found they significantly amplified investors’ trading behaviour. Those who got points for trading executed nearly four times as many trades as a control group, which according to the regulator exposes them to a greater risk of negative returns on average.
Participants who were shown a top trades list were also 14% more likely than the control group to buy or sell those stocks. The potential fallout is herding, with people following others into a stock rather than making their own informed decisions.
“Studies have shown that if provided with virtual money in a controlled experimental setting, investors subject to gamification are more likely to take risks than a control group. They’re more likely to trade popular stocks, and higher-volatility stocks,” Ramachandran says.
“We’ve also found that compared to older investors, younger investors place a higher level of trust in digital nudges by trading apps to provide them with better information on securities,” he adds. “When you have a positive disposition towards gamification and digital nudges, you’re not likely to be skeptical of the value that gamification provides.”
Ramachandran acknowledges that like many product features, gamification can be used to promote healthy behaviours. In the context of financial services, it can encourage new investors to enter the capital markets. Used right, they can also be a gateway to introduce individuals to the mechanics and nuances of different trading strategies. Expanding the scope further, he notes that gamification can be a way to nudge people into more savings.
“The problem is gamification techniques today are designed to attract attention, and they activate System 1 thinking, which is reactive and instinctive. In our paper, we suggested apps should also have features that activate reflective, deliberate System 2 thinking,” he says, referring to the two contrasting modes that Daniel Kahnemann describes in his book Thinking, Fast and Slow.
Among other recommendations, the institute also said that rather than transactions and short-term outcomes, apps should calibrate their reward systems based on long-term risk-adjusted performance. Point-of-sale disclosures, where users are shown warnings about a company’s poor business prospects or ongoing financial difficulties just as they’re about to buy its stock, could also be powerful.
“There’s no question that reward and feedback systems give positive affirmation. The question is, what are you using that positive affirmation for?” Ramachandran says. “Are you using the affirmation to tell investors that they’ve held on to a stock and are profiting from long-term performance, or staying on-track for their savings goals? Or are you celebrating the fact that they bought a meme stock today?”
