Trading platforms that reward do-it-yourself investors through “gamification” strategies are increasing the risk of losses in online portfolios, a new study says.
In a research report scheduled to be released on Thursday, the Ontario Securities Commission in collaboration with British-based Behavioural Insights Team found that investors who received rewards from trading platforms – such as digital points or online badges for buying or selling stocks – made almost 40 per cent more trades than those who were not exposed to the same gamification rewards.
Gamification is the practice of incentivizing users to trade more frequently or in larger amounts by adding game-like features to trading platforms. Competitive features such as leaderboards, which display the names of users who do the most trades per day, or images of badges or bursts of confetti that reward a first trade in a margin account or a family referral, are encouraging investors to trade more often.
As well, the OSC found investors who were shown lists of “top-traded” or “most popular” stocks were 14 per cent more likely to buy and sell the company shares that they are nudged toward. Top-stock lists promote “herding” behaviour – where a person follows what others are doing rather than deciding independently.
Herding can result in “significantly poorer” returns for investors, the report said, citing a separate study that showed an average 20-day return of minus 4.7 per cent for top stocks purchased each day. That’s because herding increases trading frequency, and can shift investors into higher-risk securities.
Other incentives, such as setting up a goal tracker, were found not to have any negative correlation to an investor’s behaviour or how often he or she traded.
As a result, the OSC is recommending regulators – such as the Investment Industry Regulatory Organization of Canada, which oversees discount brokerages – consider whether to limit digital-trading platforms from offering points or rewards for trading activity.
“More broadly, we encourage regulators to consider whether any of the gamification and behavioural techniques examined have attributes similar to recommendations and/or result in investor behaviour that is [on average] detrimental to investor outcomes,” the OSC added.
The study involved 2,430 participants, who were given $10,000 in play money to buy and sell stocks in a simulated, digital-trading environment.
During the pandemic, Ontario’s provincial watchdog began to pay closer attention to the impact of gamification on retail investing as the number of DIY investors – many of whom were new to investing – began to rise as Canadians poured COVID-19 savings into the market.
Also known as order-execution-only (OEO) websites, discount brokerages are prohibited by regulations from providing any type of investing advice to clients. But the lack of advice is now becoming problematic for trading platforms that have growing numbers of unsophisticated investors.
In 2021, more than 3.6 million new DIY accounts were opened at discount brokerages, according to data provided by Toronto-based Investor Economics, a unit of ISS Market Intelligence. That was an increase from 2.3 million in 2020, and 846,000 in 2019.
As well, a wave of mobile-only, self-directed platforms have emerged in both Canada and the United States, along with several zero-fee trading platforms, increasing the number of participants who can easily set up accounts with a few clicks on a phone.
The gamification business model first grew in popularity with U.S.-based fintech startup Robinhood Markets Inc. HOOD-Q, a zero-fee online trading platform. Robinhood began to reward its users for trading more frequently, trading with larger amounts, and trading in much riskier products, such as margin accounts.
In 2021, the U.S. Securities and Exchange Commission flagged concerns about gamification, saying the features may encourage investors to trade more often, invest in products that may not be appropriate for them, or influence their risk tolerance.
The OSC, in its report, found several incentives that can affect an investor’s behaviour. In addition to leaderboards and badges, some discount brokerages may use “gamblification” – rewards with economic benefits such as cash payouts or language that evokes gambling, such as jackpots or scratch cards.
“Trading frequency or volume is a critical behaviour of interest, given the strong negative correlation with investor return,” the OSC said in its report. “Offering rewards [points] with negligible economic value may dramatically increase trading frequency.”
The study urges regulators to close “major gaps” in empirical evidence by collecting more data through studies as well as data that can be collected directly from digital-trading platforms that have implemented gamification or other behavioural techniques.
“These actions will enable the OSC and other regulators to set new empirically-driven regulatory strategies and approaches,” the OSC added.