The tragic case of Alex Kearns, 20, a college student who killed himself in June last year after mistakenly believing he had lost a fortune to online trading app Robinhood, demonstrates the dangers of novice investors failing to understand the products they purchase, according to experts.
Kearns used the app to start trading options in his first year of college and a series of trades resulted in him seeing a negative balance of $730,000 in his account, which he thought he owed Robinhood.
His family is now suing the online broker, accusing it of allowing inexperienced investors to take big risks in complex financial instruments without providing investment guidance or the necessary customer support.
“Online trading platforms are not a risky proposition to gain access to markets. However, what worries me is investors’ behaviour and lack of financial literacy of the products they are trading,” says Ali El Adou, head of asset management at Daman Investments.
“High leverage and speculation are the most worrying factors. In 2015, trading platforms such as Alpari and many others filed for bankruptcy due to market volatility – a lesson investors should always keep at the back of their minds.”
The recent GameStop trading frenzy is another example of how trading apps offer big risks and rewards, and raises questions about how safe share-trading apps are for stock-market investors.
Robinhood has also drawn flak for restricting trading in GameStop shares and other heavily shorted companies, denying investors a chance to book profits. The platform said it limited trading in GameStop to boost its cash buffers and pay for clearing house deposits.
Akshay Nair, a UAE-based investment consultant who made a $65,000 profit in one week by trading in GameStop shares, agrees that a majority of customers using free trading apps are small retail investors who do not understand the risks.
“These platforms provide huge leverage, so people bet more than they can risk. They eventually make losses, especially in complicated products such as options,” he says.
Mr Nair says it is risky to engage in these trades without professional financial advice.
“The platform itself is not safe or unsafe. It depends on the investor’s knowledge,” he says.
Although he reinvested about $20,000 of his profit in another tranche of GameStop and AMC shares, buying 100 shares each for about $94, the stocks have continued to fall, and he now plans to book his losses. He says he has no regrets because he was willing to take a risk.
With retail investors increasingly seeking direct access to markets with the help of technology, online trading apps have become more popular. Demand surged during the pandemic due to monetary easing by the US Federal Reserve and other central banks, putting more money into people’s pockets during the Covid-19 lockdowns.
The best way to trade is to use several platforms belonging to different regulatory authorities rather than rely on a single one, no matter how advanced it may be, says Chaddy Kirbaj, vice director at Swissquote Bank Dubai. It is a safer option for investors to deal with fully regulated banks and brokers with reliable regulatory authorities, he says.
“The safety of online brokers depends on many factors, including regulations, business type, software integration, execution and the safety of clients’ money,” says Mr Kirbaj. “These apps are highly sophisticated tools that can be susceptible to technology failure, cyber attacks, hackers and disconnection.”
Traders also need to carefully read the agreement they signed with the share trading app as it “gives full legal rights to brokers to change the rules and trading conditions without any prior notice”, says Mr Kirbaj.
Karan Gurnani, a UAE-based trader in his mid-20s, says anyone looking to use an online broker must do a background check on its licence and the regulations it follows.
“A retail investor in the UAE has several options if they wish to gain access to global financial markets. For beginners, I recommend that you consult a seasoned financial adviser prior to making your investment decisions,” says Mr Gurnani, who has been investing in stock markets for a few years and manages money for more than 450 people through eToro.
He also recommends robo-adviser platform Sarwa for new investors to start easily with an investment account.
“Beginners must keep asking questions until they achieve clarity, no matter how irrelevant the question may seem. It is very important to know how and where your money is being invested and even more important to see returns on your investments, so be calculated and pragmatic in your approach,” he says.
When following the do-it-yourself method, traders must consider several risks, especially if they are new to investing or not significantly knowledgeable about the assets they are trading in.
They must not commit a large portion of capital without diversifying, says Ramzi Khleif, general manager of wealth management platform StashAway Mena.
“For example, when an investor wants to get in on the hype of some stocks, such as GameStop, they tend to put in a large lump sum to drive higher returns, forgetting that they can also lose a lot if the stock falls.”
He says dollar-cost averaging – when an investor divides the total amount to be invested across periodic purchases of a target asset into a diversified portfolio – is a safe and effective way to invest “as it removes emotion from the decision of when to buy and helps maintain the strategy you set yourself to achieve your financial goal”.
Novice investors must also be careful when taking out leverage on these trading platforms.
“Buying on margin means you can double [or more] your exposure on a stock, but it also means increasing your expected losses,” says Mr Khleif.
“Investors also run the risk of facing a margin call [which can happen when the asset falls below a certain value] and would then need to commit even more cash to an already precarious position to avoid further losses.”
He says investors should avoid the hype of pursuing the “hot stock” of the moment but, rather, stick to a consistent investment strategy and contribute to a diversified portfolio that optimises returns for their specific situation.
Recommending alternative ways to invest for those who are not knowledgeable enough to use the DIY method, Mr Khleif says robo-advisers are a “good place for investors to begin their journey and optimise their risk-return profiles through an automated approach”.
These platforms offer exposure to several asset classes such as government bonds, commodities, US equities and emerging markets, and take the work out of optimising an investor’s portfolio based on market conditions and their specific risk profile, he says.