Updated: Aug 25, 2021
“Behind the recent surge in retail investing is a younger, often new-to-investing, and aggressive cohort not afraid to employ leverage” Deutsche Bank strategists Jim Reid and research associate Raj Bhattacharyya.
Aggressive Stanley can take out his smartphone, open an app, leverage his account balance 2x, and buy GameStop. This might take 60 seconds and cost very little; maybe some interest on the borrowed funds.
Is this a good or bad thing for Aggressive Stanley? Depends who you ask.
Supporters will say bringing people into financial markets, who might have otherwise never invested, is a good thing. I would agree.
More investors might equate to higher savings rates, greater account balances, and better financial habits. So far, so good.
Free trading apps offer ease of use, miniscule costs, low friction, and (potentially) better financial habits. What could go wrong? If you've been watching the unexplainable price action of companies on the brink of insolvency, you might say everything.
The above graph shows the absurd price action of GameStop and AMC (movie chain company) over the past three months. These meme stocks have been at the epicenter of the Aggressive "Stanleys," Wall Street, and securities regulators.
The naysayers might say the gamification of these apps can lure-in novice investors that have no clue what they are getting into.
Researchers at Oklahoma State University and Emory University state these apps have "attracted a new type of uninformed equity-market participant that in aggregate has negative effects on market quality." (Source: MarketWatch)
According to the study, “What is the Stock Market?,” “What is the DJIA?” and “What is the S&P 500?” were the three most commonly visited topics on the frequently asked questions (FAQs) page for popular trading platform Robinhood.
If a herd of uninformed investors wants to donk off their money, what's the problem?
People doing outlandish things in financial markets has occurred since the beginning of time. The problem is that these apps are almost encouraging the self destruction of Aggressive Stanley.
For example, why on Earth would a broker allow leverage for a new trader? That's like giving a student driver a 600hp Lamborghini and turning them loose on the autobahn. How about driving the neighborhood in Mom's Buick station wagon first?
Predictably, Aggressive Stanley gets crushed and has no clue what happened. He might even feel victimized, as if the deck is stacked against him.
One, if you are buying stocks like GameStop and lose money, you weren't investing but rather gambling. Securities laws aren't meant to protect this type of behavior. Second, if enough people get burned, it could create a generation wary of the integrity of financial markets, which would be bad for everyone.
Interestingly, most of the shenanigans started with the industry-wide rollout of free trading. It created an unintended consequence of rapid fire trading without friction. Making 100 stock trades at Schwab would have cost you $495 in 2018. In 2021, it costs nothing, which is a good thing, if you aren't going nuts.
So, what's the solution? I don't know, but a little common sense could go a long way.
We need education on investing basics. Unless all of these people have maxed out their 401k, fully funded IRAs, and paid off consumer debt, they have no business speculating in meme stocks.
Do not allow use of leverage for inexperienced investors.
Modernization of securities laws to reflect information age. This one is a bit more complex. However, digital armies shouldn't be able to mobilize and manipulate stock prices.
Greater transparency on how these "free" trading apps make money. Hint: it's not free.
Financial markets are the greatest passive wealth creation engine in the world. The next generation of investors should have faith that the deck is not stacked against them. They can do their part by educating themselves on investing basics. Regulators should foster an environment of transparency, investor protections, and consistency. A fair and level playing field benefits everyone.