The danger of trading from home

Posted by TEBI on October 26, 2020

The danger of trading from home

 

The COVID-19 pandemic has not just sparked a revolution in working from home. It has also triggered a significant upsurge in people trading stocks from their bedrooms, with little more than an app on their phones, a ton of adrenalin and an urge to make big money fast.

The day trading trend has been variously attributed to bored Millennials stuck at home, the rise of easy-to-use, low-fee, commission-free platforms with no required minimum balance and often apocryphal stories about overnight fortunes being made.

 

The rise of Robinhood

The poster child for the trading-from-home revolution is undoubtedly Robinhood. This US start-up was created by a couple of Stanford University software geeks who built a simple application that allows people to bypass expensive brokerages and “democratise finance for all”.

Such has been the embrace of Robinhood by young day traders that the company now boasts more than 13 million users, with an average age of 31. Highlighting its success, the company has raised US$1.2 billion from investors this year to lift its valuation to more than $11 billion.

The appeal of the platform is clear. Fees are low, no commissions are charged, the mobile app is simple to use and users have instant access to deposits. It appears to be the ideal tool for small traders who want to dabble in the share market with minimum fuss.

But there is also a dark side to this sudden burst of “democratic” trading. In June this year, a 20-year-old student at the University of Nebraska killed himself in the mistaken belief that he had lost more than $700,000 trading options. Amid the resulting controversy, Robinhood delayed its UK launch indefinitely, having decided to first strengthen its core business in the US.

 

A global phenomenon

But the technology-led home trading revolution doesn’t end there. In Australia, a start-up modelling itself on the US app recently signed up 10,000 investors in three weeks. ‘Superhero’ launched in September with a flat fee of $5 per trade a $100 minimum investment.

In the meantime, regulators are starting to sit up and take notice of the large influx of neophyte investors into the market. In May, the Australian Securities and Investments Commission (ASIC) noted a substantial increase in retail activity in shares during the COVID lockdown, with many participants using short-term, leveraged strategies aimed at making a quick profit.

“Even market professionals find it hard to ‘time’ the market in a turbulent environment, and the risk of significant losses is a regular challenge,” ASIC warned. “For retail investors to attempt the same is particularly dangerous, and likely to lead to heavy losses — losses that could not happen at a worse time for many families.”

In the UK, likewise, the Financial Conduct Authority is seeking input from the public on ways of improving the consumer investment market to ensure people are not offered unsuitable products and advice — including illiquid investments that magnify risk.

And in the US, the Securities and Exchange Commission is investigating Robinhood for failing to disclose to its customers that it was selling their orders to high-speed trading firms.

Questions have also been asked about how young people with little or no understanding about the principles of investment can be let loose on complex derivative products like options during the most volatile markets since the global financial crisis.

 

The role of advice

The missing ingredient in the “democratisation of finance” would appear to be education and the important role that a financial adviser can play in teaching young people about risk-and-return, the importance of diversification and the benefit of a long-term view.

Lowering costs and demystifying investing are admirable initiatives, as is improving access to a market long dominated by expensive intermediaries. But cost on its own is not enough.

Profiting from buying and selling shares around short-term price movements is a hit-and-miss occupation and can exacerbate risks for investors in volatile markets. Instead of “playing” the markets, people who try to invest this way often end up getting played themselves.

 

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