Abacus: Dangers of Day-trading
Witthaya Prasongsin
Look up day trading anywhere, and the results will be quick to note that it is a risky venture. What used to be the realm of financial analysts and wall street gurus is now common practice, thanks in part to the surging popularity of the investing app Robinhood.
Day trading is often viewed as a high-risk investment due to its undiversified and speculative nature. Most all financial advisors will note that investment in the stock market is most useful in the long term, with guaranteed returns of around 7-8% annually when your money is placed in an S&P 500 index fund for example. The inverse to this idea of long-term holding is day-trading. The practice itself is a fairly new phenomenon, as the rise of the internet and near-instantaneous market information, and trades through platforms like E-Trade, allowed for savvy investors to capitalize on market volatility rather than playing the long game. Where stock market investment used to be a decision with long-run implications, capitalizing on the sustained improvement of company performance, day trading, and the evolution of the internet that empowered it, has allowed investors to profit off of price fluctuation rather than growth. While the practice made millions for many during the dot-com boom, these investors felt the crippling effects of the bubble bursting in the early 2000s. Following this collapse, day-trading retreated to the realm of Wall Street. That remained the case until recently, as the introduction of zero-fee platforms resulted in what many are calling a “retail revolution.”
Since its founding in 2013, Robinhood Markets, who is seen as the catalyst for this revolution, has undercut the big brokerage investment firms, rethinking who investment is for and how it is done by eliminating trading fees, minimum deposits and even allowing for just fractions of shares to be bought at a time. One of the company's goals is to “democratize trading”, according to its founders, making trading accessible to those without the capital that was previously necessary through a streamlined and ‘no frills’ approach. These enticing benefits not only help young investors, detached from the gatekept world of finance, enter the market, but have allowed Robinhood to garner almost $91 million in revenue during Q1 of 2020 alone. These figures are only attainable by a massive influx of new traders looking to get into the day-trading game, many unaware of the risks.
This “revolution” carries with it a dark underbelly, where inexperienced investors can enter the day-trading metagame without the know-how necessary to minimize risk. Nowhere is this more apparent and tragic than the story of one Alex Kerns, a college student who took his own life after believing he had accumulated debts totaling almost $730,000 day-trading on Robinhood. These perceived losses were in part due to the controversial options trading feature within the app. Options trades, allowing traders to wager on the direction of a stock and potentially supercharging their profits or their losses, have seen massive increases in volume during the pandemic and the vast majority of Robinhood's revenue came from options.
The risk associated with options trading has led some young investors to look for guidance. For those looking to enter the market with more disposable income, this could manifest in a financial advisor's services. For others, particularly young people, more dangerous sources fill the gap. One emerging market in this service is TikTok, where the videos, including the "investing" hashtag, many of which feature content creators flexing their profits and promising tips and tricks, have accumulated hundreds of millions of views. While most users are sure to use their own judgment when sorting sound financial advice from the bad, concerns lie in these viral investors, more likely to showcase their profits than their losses, highlighting Robinhood's capabilities without a good-faith evaluation of the risks of day-trading. While Robinhood has been quick to make changes to the platform after this tragedy and controversy surrounding access to options trading, including the creation of a page for trading lessons, tips and tricks, Robinhood’s order flow payment model (where Robinhood profits off the margin per trade) still entices them to keep day-traders moving high volume. Options make this a reality. Beyond this, Robinhood has been criticized for gamifying their platform to increase trading volume, using push notifications, achievements, and even digital confetti after successful trades all in the hopes of increasing volume, their revenue, and therefore the risk for their customers. In all this digital polish, sometimes the real-world consequences can be forgotten.
For those few investors with the capital and know-how required to day trade effectively use every tool they can to minimize risk. Stop-limit orders, allowing for stocks to be sold instantaneously if they approach a certain price, and diversification can offer security from the possibility of taking massive losses but Robinhood’s tendency to draw in investors without that knowledge creates a volatile trading environment for those just getting started. While Robinhood has done well to begin integration of training and teaching tools, there are countless stories recounting massive losses nearing hundreds of thousands of dollars taken on by rookie investors on the app.
As the pandemic ravages on, many young people are concerned about their financial futures. With this, the security and growth that the stock market offers present enticing opportunities for young investors. This is especially true when it has never been so easy thanks to firms like Robinhood. All that to say, investing early and looking at the long term is a smart decision. While this “retail revolution” has led to a resurgence of day-trading, championed by Robinhood and their push notifications or an influencer’s post, has driven home quarterly revenue gains for some, the results are real and devastating for others.
