Does Gamified Trading Stimulate Risk Taking? (2021)
Philipp Chapkovski, Mariana Khapko, Marius Zoican
Swedish House of Finance Research Paper No. 21-25 via SSRN
Among the most important financial innovations of the last years are online brokers that offer cheap or in the meantime even free trading. All else equal, this is great because such services democratize access to financial markets and make it easier for people to invest. However, it’s not all glamorous. The online brokers leverage technology to encourage people to spend more time on their applications and an important part of this is gamification.1There is nothing inherently wrong with that. This is their business model and Facebook, Instagram, and Co. are no different. But I think it’s still important to understand how such elements could impact our behavior. This week’s AGNOSTIC Paper examines the consequences of such elements in finance. I think at least since the GameStop Mania in early 2021, we all agree that there are some.
Everything that follows is only my summary of the original paper. So unless indicated otherwise, all tables and charts belong to the authors of the paper and I am just quoting them. The authors deserve full credit for creating this material, so please always cite the original source.
Setup and Idea
According to the authors, gamification is “the use of game design elements in non-game contexts.” If you are somewhat interested in consumer tech, you probably know a lot of examples for this. For instance, the activity rings on the Apple Watch or any type of digital badge. If I think about it, it’s no surprise that the new trading apps also included such features. There are for example apps in which digital confetti drops after completing a transaction. Although this is a new level of non-sense, it’s nothing new that brokers try to nudge their clients to do more transaction. Elements like “Top Movers” or “Daily Stories” have the same purpose and exist for years.2Interestingly, the authors cite another paper which shows that the “Top Movers” tab on Robinhood steers investors to more volatile stocks and ultimately leads to underperformance. Important lesson: never ever look at “Top Movers”.
The authors analyze how such gamification elements impact the behavior of retail investors. Unfortunately, this is not so easy to get out of the data because of the so called endogeneity problem. The idea behind this econometric jargon is actually quite simple. Even if you find a correlation between gamification and risk taking, you don’t know if this is also causal. For example, a positive correlation doesn’t tell us if gamification leads to more risk-taking or if gamified trading apps just attract investors who are risk-seeking by themselves (and therefore take more risks also without gamification).
To overcome this issue, the authors employ an experimental approach that is actually quite funny. The key advantage is that within this experiment, participants are randomly allocated to gamified and non-gamified trading simulations. It’s therefore possible to isolate the impact of gamification with a reasonable degree of confidence.
Data and Methodology
The important part of the paper is of course the experiment. Participants face 9 rounds of trading in a hypothetical financial market. At the beginning of each round, they have one asset that they can sell at any time. The starting price is $10 and the price changes every 2 seconds. With equal probability it increases by $1, $2, or remains unchanged. There is also a small probability that the price of the asset crashes to zero (2% or 5%). Participants are informed about the crash-probability but not about the possible price-changes. Each round lasts 60 seconds or until the asset crashes to zero. The authors conduct the entire experiment online and recruit participants from North America.
Participants only have to decide when they sell the asset and the timing reveals something about their risk-attitudes. Risk-averse participants will immediately sell the asset and secure the gain of $10. On the other hand, risk-seeking participants will gamble for higher payoffs and accept the small chance of a total loss. Also note that the participants receive a real-world payment at the end of the experiment that is based on the asset value of a randomly selected round. So they have monetary incentives to do the experiment seriously.
The interesting thing is now of course the gamification. The authors randomly split participants in two groups. Both start with a training round without gamification. After that, the first group continues for 4 rounds on the non-gamified platform while the second group switches to the gamified version. After those 4 rounds, the groups switch again and trade another 4 rounds on the respective other platform. So in the end, each group had the same exposure to gamification but in a different order. The authors also vary the crash probability to simulate different risk-levels. The following screenshots show the two trading platforms. I think we all see the differences…
The gamified trading platform has more buttons, symbols, colors, and a (honestly, pretty cool) Scrooge McDuck “trading mascot”. There is also a chat window with messages and animations that should encourage participants to hold the asset for longer (i.e. take more risk). These contents mostly come from the now famous WallStreetBets reddit forum and are summarized in the table below.3I don’t recommend to waste your time and mental energy with this kind of stupidity. But for those who want to try, here is the link…
All these gamification elements are of course just worthless attention-grabbing distractions (although I still find the Scrooge McDuck pretty cool). The experiment seems funny (and the setup is honestly very good), but the results are actually quite serious. Gamification changed the behavior of the 605 participants considerably. And, as you probably expected, not for the better…
Important Results and Takeaways
Gamification encourages investors to take more risk
In line with the established methodology for experiments and surveys, the authors use Tobit regressions to estimate the impact of gamification on trading. The result: participants tend to hold the asset for longer when trading on the gamified platform and consequently sell the asset at higher prices. Given the setup of the experiment, this is consistent with the idea that gamification encourages risk-taking.
Importantly, the authors also show that the impact of gamification depends on the crash probability. During rounds with higher crash probability (i.e. more risk), the impact of gamification is even stronger. This is in line with the observation that many investors use the new gamified trading apps to trade risky assets like options or cryptocurrencies. In my opinion, this result is somewhat unfortunate because investors (especially those without experience) should actually become more cautious when trading very risky assets.
Inexperienced investors without financial knowledge are most vulnerable
To test the impact of gamification even further, the authors also ask participants to answer several questions that test their financial literacy.4Participants receive a small payment for each correct answer of the test, so they are incentivized to do it properly. They also use the group of participants that was exposed to gamification in the last 4 rounds of the experiment as a proxy for “experienced traders”.5The idea is that if you can trade 4 rounds without gamification, you gain some experience and are less likely influenced by Scrooge McDuck and Co. on the gamified platform. The results are again in line with expectations: participants without experience and less financial literacy tend to be more vulnerable to gamification than others.
I think this result is again unfortunate because those investors who need the most protection are actually the easiest to manipulate. But this has never been different in the brokerage industry and digital Scrooge McDucks are just the evolution of stock tips and other types of stupidities that exist for years. So if we criticize trading apps for gamification, we must also criticize “traditional” brokers for stock tips and similar distractions.
Conclusions and Further Ideas
I think the implications of the experiment are straight forward. Targeted gamification of trading apps indeed appears useful to encourage investors to take more risk and do more transactions. Since it is the business model of trading apps to earn commissions on their order flow, this is not really surprising. The insights are of course especially important for regulators and the issue is already on the table of the Securities and Exchange Commission.6See for example here and here. Given that inexperienced investors with little financial literacy are most vulnerable to gamification, this is probably not so bad.
My personal view on the issue is somewhat mixed. On the one hand, I really like the fact that online brokers made trading de-facto free and also more accessible. I think this is great for investors and I am a happy user of TradeRepublic myself (a popular German trading app). On the other hand, I also believe that investing is a serious issue and shouldn’t become a smartphone game.
So what shall we do? My personal strategy is as follows. I use the app to benefit from its simplicity and low costs but I deactivate all potential distractions. No notifications, no daily stories, and I avoid the “Top Movers” at all cost.7In my opinion, “Top Movers” are really one of the worst things you can spend time on. They don’t help you to become better and just create bad feelings of regret. It was so obvious that this BioTec company you never heard of before gets acquired at a 100% premium, right? No, it wasn’t. This is hindsight. I also try to automate as much as possible. Don’t invest your monthly savings manually but create a savings plan. Avoid market orders and use limit orders instead. This should already prevent some impulsive decisions and I am convinced that with such simple precautionary actions, the trading apps offer great value.
But unfortunately, I also believe that the impact of gamification is like all other behavioral biases. Awareness is helpful but our brain will never be completely immune against them. I mean, who doesn’t want to continue trading if a digital Scrooge McDuck tells you to do so?
- AgPa #74: Peer-Reviewed Research is Not Helpful to Predict Returns – Really?
- AgPa #73: Country and Industry Momentum
- AgPa #72: Machine-Reading of Private Equity Prospectuses
- AgPa #71: Go Where the Earnings (per Share) Are
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|There is nothing inherently wrong with that. This is their business model and Facebook, Instagram, and Co. are no different. But I think it’s still important to understand how such elements could impact our behavior.
|Interestingly, the authors cite another paper which shows that the “Top Movers” tab on Robinhood steers investors to more volatile stocks and ultimately leads to underperformance. Important lesson: never ever look at “Top Movers”.
|I don’t recommend to waste your time and mental energy with this kind of stupidity. But for those who want to try, here is the link…
|Participants receive a small payment for each correct answer of the test, so they are incentivized to do it properly.
|The idea is that if you can trade 4 rounds without gamification, you gain some experience and are less likely influenced by Scrooge McDuck and Co. on the gamified platform.
|See for example here and here.
|In my opinion, “Top Movers” are really one of the worst things you can spend time on. They don’t help you to become better and just create bad feelings of regret. It was so obvious that this BioTec company you never heard of before gets acquired at a 100% premium, right? No, it wasn’t. This is hindsight.