Why I’m No Fan of Trading Apps That Treat Investing Like a Game

The recent media coverage of the GameStop stock saga has put the spotlight on day traders who are using social media and a new generation of no-cost trading apps to manipulate the market by driving up the prices of distressed stocks.

It shouldn’t be surprising to you that, like practically all investment professionals, I’m no fan of day trading or any other investment activities geared toward making a quick buck from buying and selling individual stocks.

My clients at Canby Financial Advisors understand this. They know that smart investing isn’t about profiting from individual stock trades. It’s about using the risk and return characteristics of different categories of stocks and bonds to build a diversified portfolio that is fine-tuned to align with their specific investment objectives, time frame and risk tolerance.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Yet, I’ve been hearing more and more from clients and friends whose children, nieces and nephews are dipping their toes in the stock market by opening accounts with a new generation of smartphone-based brokerage platforms.

High Risk, Dubious ‘Rewards’

Unlike most traditional self-directed online brokers, which encourage responsible investing, many of these new apps make it easy for novices to get in over their heads — and underwater — quickly by encouraging them to make impulsive, uninformed, high-risk trading decisions.

They prey on the same addictive behaviors that keep so many people glued to their smartphones. And they use many of the same “bait-and-play” techniques that gaming and gambling sites use to hook players into spending — and losing — more of their money.

That’s why I call them “game-day-trading” apps.

Many of these apps get new users signed up and trading in minutes. Some have no minimum account balances, and most don’t charge commissions for stock trades. They do everything in their power to encourage people to start buying and selling stocks without helping novice investors understand the risks of uninformed trading.

What the worst apps have in common is that they encourage you to trade often. They use slick interfaces and flashy graphics and sounds to keep you glued to your screen. Some “reward” you with shares of stocks when you sign up. Once you “accept” these shares you’re bombarded with text and email messages with updated share prices. Then you start receiving an endless stream of “hot stock tips” and other incentives to keep trading.

And therein lies their insidious genius.

The Pleasure Unprincipled

Developers deliberately program these apps to exploit addictive behaviors. They use the same techniques that drive armchair quarterbacks to bet on fantasy sports teams and weekend gamblers to become the “fish” at online poker and blackjack tables.

All of these apps are designed to stimulate the production of dopamine. Dopamine is the “pleasure hormone” that the brain releases when we eat delicious food, exercise or engage in in-person or online activities we consider to be beneficial, exciting or ego-boosting. It’s the chemical that makes us want more.

Game-day-trading apps create a “dopamine loop” that exploits users’ vulnerability to get-rich-quick schemes and fears of missing out on “can’t-miss” opportunities.

The more you trade, the more you’re encouraged to trade more. It doesn’t matter whether you’re losing your shirt along the way. It’s the volume of trades — not the results — that count.

Some of these apps employ “gateway” techniques to encourage users to move up from stocks to trading options and leveraged exchange-traded funds (ETFs). Very few investors understand how these highly speculative securities work — and how much more they can lose if they make bad trading decisions.

Most traditional online brokers employ safeguards to make sure investors fully understand their characteristics and risks before they provide access to these securities. But some of most popular game-trading apps don’t offer such protections. And investors end up losing even more, without understanding why.

And here’s another thing these firms don’t always mention: the short-term capital gains taxes users may get walloped with if they do a lot of day trading.

I honestly don’t understand how game-day-trading brokers can get away with these irresponsible practices. In the financial industry, brokerage firms that try to convince clients to constantly buy and sell stocks are known as boiler rooms. Regulators often sanction these firms and try to shut them down entirely. In my opinion, using text messages and flashy notifications flogging hot stocks is just as bad. Hopefully, the industry will bear down on these companies to curtail these virtual boiler room practices.

Now, not everyone using these apps is necessarily involved in day trading. Some of these game-day-trading brokers claim that most users are long-term investors. I’m a bit skeptical about this, given that these firms profit from trading activity, whether they’re paid commissions by investors or get paid by high-speed traders who execute the trades (an issue that deserves its own separate discussion).

Moving from a Trading to an Investing Mindset

I often have conversations with people who have been burned by day trading. They usually ask me, “What am I doing wrong?” I usually answer that they’re asking the wrong question. Because, as I already mentioned, there’s a huge difference between day trading and investing.

I tell them that if they want to reserve a small pool of “fun money” to play the market that’s fine. But if they’re concerned about saving enough for retirement, their children’s higher education, the purchase of a new home or other financial objectives, they need to think like strategic investors, not impulsive stock traders.

Smart investors understand that the purpose of investing isn’t to make quick profits but to put their money to work in a manner that aligns with their specific short- and long-term financial goals. This usually means creating separate pools of money for each goal and dividing it among a targeted and diversified mix of stock and bond investments.

I’ve also spoken to several young people who have gotten hooked on these apps. Their experiences have convinced me more than ever of the need for schools to teach financial literacy courses. The earlier that students learn about how investing and financial planning work together, the more open they may be to thinking about investing as a tool for achieving financial security, rather than simply as a thrill-seeking hobby.