How Gamification Can Mislead Traders Into Potentially Reckless Trading

The rise of do-it-yourself or self-directed trading has been an inflection point in the history of capital markets, as it marks the point in time when individuals could easily invest in stocks, ETFs or cryptocurrencies via electronic trading platforms. While lowering the proverbial barriers to investing has allowed more individuals to become investors, it has also facilitated and amplified individuals’ risk-taking behavior, with many electronic trading platforms encouraging such behavior through gamification.

What Is Gamification?

Gamification is the application of typical game-play elements (e.g., points, competition with others, rules of play) to other areas of activity to encourage engagement with a product or service. Though gamification is present in various industries, in the realm of investing, it aims to simplify and make the traditionally complex world of finance more accessible, user-friendly, and engaging while encouraging investors to participate in the market and learn about investment strategies actively.

Gamification, Changing Investor Behavior

Gamification has been an essential catalyst for electronic trading platforms, serving as a form of edutainment that has attracted and retained individuals on these platforms. The CFA Institute has researched the effect of gamification on investor behavior and published its findings in the 2022 CFA Institute Investor Trust Study entitled Enhancing Investors' Trust. They surveyed more than 3,500 retail and 976 institutional investors across 15 markets on their opinions on gamification and cryptocurrencies and found that approximately two-thirds of investors under the age of 45 have trading accounts, compared to 54% of retail investors overall. Across age groups, one-fifth of the users self-reported entertainment/speculation as the primary reason for using a retail trading account, with the other four-fifths citing investing to meet long-term goals as the primary reason.

Simply put, the gamification of investing induces a thrill or sense of euphoria within a significant cohort of individuals utilizing digital trading platforms, with the non-monetary benefits of these platforms taking precedence in investors’ minds. Furthermore, the impact of social media in popularizing the trading of stocks or utilizing options, further encourages individuals to trade in a gamified manner.

Gamification Can Have A Negative Impact On Investing

The most public example of the implications of gamification is GameStop Corp. GME and the success of other social media-driven meme stocks. As detailed in the U.S. Securities and Exchange Commission (SEC) Staff Report on Equity and Options Market Structure Conditions in Early 2021, GME's intraday share price increased approximately 2,700% from its intraday low on January 8, 2021 to its intraday high on January 28, 2021, followed by a decrease of over 86% from that day to the closing price at the end of the first week of February 2021.  

The daily closing price changes at the end of January were also highly volatile in dollar terms, ranging from a rise of $199.53 (between January 26 and 27) to a fall of $153.91 (between January 27 and January 28). During this period, there was an increase in individual accounts trading GME. By January 27, the number of unique accounts trading GME on a given day increased from less than 10,000 at the beginning of the month to nearly 900,000.

Like GME's equity trading activity, GME options trading activity increased significantly. From the beginning of 2020 through September of that year, GME options traded a median of about 16,000 contracts per day, with a maximum of about 172,000 in one day, with a median dollar volume totaling just over $800,000 per day and a maximum of about $42 million in one day. In the fourth quarter of 2020, GME options traded a median of about 84,000 contracts per day, with a maximum of about 560,000 in one day, with a median dollar volume totaling approximately $10.5 million per day, and a maximum of about $120 million in one day. Individual customer accounts made up a high percentage of options trading in GME during this time.  Several retail brokers facilitated this activity, with three brokers representing over 66% of individual customer accounts trading GME options.

The fallout from GameStop's volatility led the SEC to investigate investor safeguards on prominent electronic trading platforms. The SEC's inquiry brought to the forefront the operational conflicts of interest, namely payment for order flow (PFOF), that are in place with many electronic trading platforms and market makers. In principle, PFOF incentivizes brokerages, such as electronic trading platforms, to route orders to market makers that pay the highest PFOF, which may not always align with getting the best execution for the customer. Since electronic trading platforms benefit monetarily from increased trading on their platform, gamification is how these platforms retain and compel users to trade continuously, ultimately profiting from their habit-forming behavior.

Recently, the SEC proposed the Conflicts of Interest Associated with the Use of Predictive Data Analytics rule, which aims to diminish the adverse effects of gamification and eliminate conflicts of interest that may be present. Specifically, the rule would require that where technology places a broker's or adviser's interest ahead of an investor's, such conflicts of interest must be "eliminated" or "neutralized."

Gamification in investing also includes other drawbacks. It may promote heightened risk-taking where rewards incentivize users to take chances they may not consider in a more conventional investment environment. Gamification can foster a short-term mindset, seeing investors potentially missing out on the advantages of compounding returns because they focus on the immediate feedback involved in gaming. On average, increased trading frequency, as encouraged by the dynamics of gamification, generates more income for trading platforms, but has a negative effect on retail investors.

Learning In An Intentional Manner

While the gamification of investing has often been the gateway through which individuals have familiarized themselves with capital markets, there are alternate avenues through which investors can develop a strong investing aptitude without increased risk-taking. 

Given the increasing popularity of options, platforms such as The Options Institute provide both beginners with options trading and professional traders with a forum to familiarize themselves with foundational knowledge on options or to learn new developments within the investment derivatives landscape. Owned and overseen by Cboe Global Markets CBOE, the leading derivatives-based index provider in the world, Cboe's Options Institute provides comprehensive courses and tools, equipping investors with the knowledge needed to navigate the complexities of options trading effectively.

For retail investors that want to implement their options knowledge in a measured fashion, Cboe's XSP Index options are worthy of exploration, as they are based on the S&P 500 Index, but are designed to be smaller in size, making them more accessible to individual investors and smaller traders. With benefits like lower cost than standard-sized index option contracts, cash settlement, and European-style exercise, they can be a versatile tool for hedging, speculation, and income generation. As individuals gain more experience, Cboe Global Markets has a wide array of investment products that investors can utilize dutifully to execute their investment goals.

Though gamification makes investing fun, it is a fleeting aspect of the investment experience that has taken advantage of investors thus far. In contrast, education platforms such as The Options Institute provide a pathway of practical learning and tutelage for individuals desiring to grow their investing skills meaningfully and gradually.

Featured photo by Anne Nygård on Unsplash

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