There has been a surge in popularity in retail trading platforms during the coronavirus pandemic. These allow people to easily invest money using apps which act as online brokers.

This Insight explains the reasons for, and possible consequences of, their popularity.

What are retail trading platforms?

Retail trading platforms allow non-professionals to easily invest their money. This might be in the stock market, the currency market, or in cryptoassets like bitcoin.

The UK’s largest investment platform, Hargreaves Lansdown, reported a 40% jump in net new business in the final six months of 2020. The average age of platform users has dropped from 54 in 2012, to 47, reflecting a rise in younger investors.

Another platform, Trading 212, which describes itself as the UK’s number one trading and investing app by number of downloads, announced on 2 February 2021 that it would temporarily pause new account openings due to huge demand.

Why are trading apps becoming popular?

Reasons for the surge include:

  • so-called “lockdown boredom”, with people looking for new and exciting activities;
  • an increase in pandemic-related disposable income for some;
  • low interest rates in the UK, meaning little or no reward for savings stored in bank accounts; and
  • greater volatility in the financial markets during the pandemic, meaning opportunities for big gains. For example, shares in electric vehicle-maker Tesla increased by over 700% in 2020. In February 2021, the price of bitcoin hit record highs, rising above $50,000.

The upside

More ‘ordinary’ people trading means more people can benefit from the wealth created by gains, rather than only professional investors and funds.

Many retail traders argue that more of them influencing the stock market is a good thing. Recently, a large number of small investors organised on the online forum Reddit, and bought shares in struggling companies like Blackberry and video game chain GameStop. This sent their share prices up and caused professional investors who had bet against these companies to incur significant losses. Some commentators reflected on the parallels with the ‘Occupy’  protests a decade ago.

Although subsequent analysis has suggested the influence of retail investors may have been overstated, the general argument is that greater influence for small traders will lead to a fairer and more ethical market.

The risks of retail trading

The risks to retail traders are high. First, stock markets and cryptoassets are volatile; prices can drop or crash and thousands of pounds can be lost in minutes.

Secondly, many professional investors ultimately invest on behalf of ‘ordinary’ people. This includes pension and other funds attracting retail investment. Millions of retail traders putting their savings into the stock market or other volatile assets, without a coherent strategy, can cause disruption for ‘ordinary’ people benefitting from rises in asset prices.

Thirdly, investment orthodoxy suggests that share prices, for example, should relate to the underlying prospects of that business. Buying a share for emotional or political reasons, or even because social media users are speculating that its price will go up, is a risky strategy. If the underlying business is not fundamentally sound it could fail, and its share price eventually crash.

The same principle applies to cryptoassets, which is why the Financial Conduct Authority (FCA) warned investors in cryptoassets in January 2021 that they should be “prepared to lose all their money.”

Risky ‘free’ advice and trades

Traders often mimic the trades of others, effectively delegating their investment decisions. Many retail traders use social media as a key source of investment information. Features like ‘CopyTrader’ on the platform eToro allow investors to automatically copy the trades of experienced traders.

Some trading platforms now also offer “commission-free” trading, in which users are not charged for each trade they make. There are concerns that these may be used as incentives to attract users, before easing them into far more lucrative, and risky, products such as contracts for difference (CFDs). CFDs are essentially a bet rather than the purchase of an asset, and often involve borrowing money.

In recognition of their high risks, in 2019 the FCA restricted the availability of CFDs, limiting how much could be borrowed and requiring firms to warn potential customers of the percentage of their retail clients that lose money using them.

How are platforms regulated?

Dealing in investments is a regulated activity in the UK, so trading platforms require authorisation from, and are regulated by, the FCA. The FCA can intervene if it feels that consumers are being harmed.

During the market frenzy over GameStop and other stocks, several overwhelmed online platforms restricted users from being able to buy shares in certain companies. Trading 212 said it did so “in the interest of mitigating risk for our clients.” Outraged retail traders, however, accused such platforms of “market manipulation”. Figures including US Democratic congresswoman Alexandria Ocasio-Cortez, Tesla boss Elon Musk, and politician Nigel Farage spoke out in favour of the retail traders and against the platforms.

In a statement on 29 January 2021, however, the FCA broadly defended the actions of the trading platforms, saying that “Broking firms are not obliged to offer trading facilities [the ability to trade] to clients.” It said it would take appropriate action, “wherever we see evidence of firms or individuals causing harm to consumers or markets.”

Responses to parliamentary questions on this issue have largely reiterated the FCA’s position.

About the author: Ali Shalchi is a researcher at the House of Commons Library, specialising in banking and financial services.

Photo by Nick Chong on Unsplash