The recent frenzy of GameStop shares due to the rallying of retail investors has shown us that the notion of individuals as rational beings in traditional economics may no longer hold true.
Many critics labelled the GameStop rally as an "irrational exuberance", in large part because the stock rally did not appear to be based on any underlying economic fundamentals, other than a concerted effort by traders on Reddit. It has also inspired retail investors the world over to take similar action, with a Malaysian-based subreddit called Bursabets having started shortly after the GameStop rally began.
In a joint statement following the incident, the Securities Commission and Bursa Malaysia advised Malaysian investors to be cautious of social media chatrooms that try to influence investors to buy or sell certain stocks based on speculation or rumours.
This "irrational" behaviour underpinning the GameStop rally is not new – we have seen retail investors create huge fluctuations in the market, from the Dutch Tulip Mania in the 17th century, to the more recent dotcom bubble of the 1990s. What makes this recent episode different, however, is how it reflects the intersections between a changing financial landscape and investor behaviour.
When easy-to-use zero-fee trading models like Robinhood were pioneered in 2013, they invigorated retail investors to participate in markets as these apps removed barriers-of-entry for retail investors while disrupting the industry by forcing many other traditional brokerages to go down the zero-fee route as well.
Behavioural research has suggested that people are inclined to overvalue free products even if the price drop is relatively low. People tend to fear making bad deals and suffering losses, but the perception of "free" eliminates this fear. In this context, zero-fee trading may encourage investors to take more risk than they usually would as their opportunity cost lessens.
The gamification of investing apps has also raised concerns that it makes investing appear too fun and easy, encouraging impulsive trading and exposes investors "to unnecessary trading risk", as claimed by Massachusetts securities regulators against Robinhood in December 2020.
While zero-fee trading has not yet arrived in Malaysia, the advent of digital-only brokers has brought down the cost of trading in the equity market, and this had led to an increase in retail participation, particularly during the pandemic. From March 18 to June 30 2020, Rakuten Trade had activated almost 50,000 new accounts, with 80 per cent of customers being below 40.
Social media platforms also played a large part in the GameStop rally. What started as a few posts on Reddit eventually led to a global phenomenon, framed as an epic battle between Big Finance and the Internet. As traders began to mobilise on Reddit, the rally was further fuelled by activity on other platforms.
The very nature of social media capitalises on an individual's social preferences and the large amount of time spent to build an accessible contact point, create positive feedback loops and a sense of community and belonging, which could be particularly attractive during a pandemic when many people feel physically and emotionally isolated.
Social media platforms have also famously harnessed algorithms designed to keep people engaged amidst limited attention spans. This, coupled with the above factors, make investors more susceptible to misinformation and herding behaviour, particularly if there is an overreliance or belief in influencers or even other forum participants.
Behavioural research has also shown that investment decisions of community members have a casual effect on an individual's decision making – this could also amplify the "Fear of Missing Out", particularly if one sees peers making profits from stock trades. While some of these contents on social platforms are educational, many tend to only post about their wins and not losses, which can bolster overconfidence and amplify the herd mentality.
A generation of digital natives tooled up to their eyeballs with online instruments and physically grounded by the Covid-19 pandemic are emerging as a new class of investors shaping the market.
A study showed that more than half of millennial and Gen Z investors said they've been trading more often since the Covid-19 pandemic began, compared with just a 30 per cent increase for the general population. This trend is in line with what is happening in Malaysia, where 64 per cent of CDS account openings on the Bursa Anywhere app has been by investors aged 25-40.
Research has shown that this generation of digital natives care deeply about social justice and community issues. Results from the Deloitte Global Millennial Survey 2020 further reaffirmed findings that millennials have no qualms starting or stopping business relationships based on factors that reach beyond personal experiences, like the environment, unequal pay, or business' political stance.
As a generation who grew up in the aftermath of the Global Financial Crisis and now the pandemic, many millennials and Gen Z feel that they have lacked opportunities at the expense of large institutions profiting. Conversation on WallStreetBets highlight that, at least for the initial participants of the GameStop frenzy, a key underlying motivation was to rally against a system perceived to be championing Wall Street elites amidst increasing inequality.
For investors today, the wealth of data, omnipresent social media and rapid fintech advancements can prove to be a double-edged sword especially in terms of discerning reliable sources from speculative ones. To avoid falling into an "information pitfall", one should constantly keep abreast of happenings in the markets and understand the underlying behavioral factors contributing to a particular trend to make more informed investing decisions.
The GameStop saga shows that markets must adapt to a world where retail investors are gaining some of the power long held by big financial firms. ICMR's earlier report titled 'Enhancing Financial Literacy in a Digital World: Global Lessons from Behavioural Insights and Implications for Malaysia' discussed how the advent of digitalisation could play a huge role in changing the ways investors behave in the capital market, but that it could also be a double-edged sword, for better or for worse.
The most recent incident with GameStop is proof that this is already happening, and that the intersections between investor behaviour and digitalisation can be consequential for the future. While financial literacy remains key, the traditional means of financial education no longer suffice. We now know from our current understanding of human behaviour that there are deeper psychological triggers acting behind investors' decision-making process.
As businesses exploit these behavioural loopholes to target consumers and investors, it is imperative that policymakers too, do the same. This could include harnessing data points for more targeted and segmented investor outreach, collaborations with social media influencers, working with industry players on tools that can encourage long-term savings and investing, as well as using behavioural insights as a measurement tool to evaluate policy effectiveness.
* The writer is Senior Research Analyst at ICMR. The full version of 'The GameStop Trading Rally: Understanding Investor Behaviour' is available on the ICMR website
The views expressed in this article are the author's own and do not necessarily reflect those of the New Straits Times