Gamification of Stock Trading: Losers and Winners
| Abstract | |||
| Gamification of stock trading is a novel practice by brokers to incorporate game-like features to increase clients’ engagement with trading. This study examines how the market reacts to the introduction of 142 gamification features in the mobile trading apps of 17 major U.S. brokers. I find that the gamification of trading can be viewed as a double-edged sword. It alters and worsens retail traders’ strategy by reducing their returns and increasing return volatility. However, it also reduces costs and risks for liquidity providers by making retail order flow less toxic, leading to a positive effect for the rest of the market. | |||
| Conferences |
| ||
Introduction
Gamification acts as a catalyst to significantly boost human engagement in a given task. It has been widely used in education (Caponetto, Earp, and Ott (2014)), business (Wünderlich, Gustafsson, Hamari, Parvinen, and Haff (2020)), and healthcare (Johnson, Deterding, Kuhn, Staneva, Stoyanov, and Hides (2016)). Meanwhile, the all-time high participation rate of retail investors (McCabe (2021)), the recent case of market manipulation with meme stocks (Pedersen (2022)), and continual debates in the Securities and Exchange Commission about the regulation of brokers strategies in the U.S. to enhance clients’ engagement (SEC (2021)) call for a market microstructure study of gamification.
I add to this literature by analyzing updates of major U.S. brokers’ mobile trading apps. The updates are typically accompanied by developers’ notes about the purpose of an update. Based on these notes, I identify updates that are associated with gamification of a trading process. The results suggest that gamified updates drive retail traders to take more risks and diminish their returns. In the meantime, trading costs decrease, and market quality improves for the rest of the market.
The sample of app updates made by brokerage firms comes from MobileAction (https://www.mobileaction.co/), which stores the data for all apps in the App Store starting from 2018. I collected a sample of updates for 17 major U.S. brokers’ mobile trading apps from 2018 to 2021. In total, 142 updates introduced new game-like features into the apps.
The results show that gamified updates increase retail trading volume and do not substantially change the number of brokerage app users. These findings suggest that gamification enhances retail trading volume by increasing the engagement of existing app users. Unfortunately, gamification weakens the trading strategy of retail traders. It diminishes intraday retail trading return and increases return volatility. There is a bright side, however.
Gamification makes retail order flow less toxic for the counterparts of retail traders, i.e., liquidity providers. First, a decrease in retail return following gamification implies a decrease in adverse selection costs. Second, retail volume imbalance decreases post gamified updates, which makes inventory management easier for liquidity providers.
Eventually, these benefits go beyond market makers and disperse to the rest of the market. Transaction costs, proxied by quoted, effective, realized spreads, and price impact, decrease post gamified updates. Moreover, market quality improves, which is captured by an increase in traded volume and a decrease in market-wide price and return volatility.
The aforementioned results have substantial economic significance. The cumulative effect of all gamified updates in the sample is an increase in retail traded volume by 21.07% and a decrease in retail return by 27.78%. The overall market benefits from these changes, as the effective spread declines by 16.55%, and trading volume, besides retail trading volume, goes up by 12.23%
Related literature
This study is related to the literature that examines retail trading. Earlier works show that retail traders are unsophisticated and tend to be lured by behavioral biases (Barber and Odean (2000); Barber and Odean (2008)), while later studies indicate that retail traders may predict future returns and use a contrarian strategy to provide liquidity (Kaniel, Saar, and Titman (2008); Kelley and Tetlock (2013)). The most recent findings about retail traders vary. Barber, Huang, Odean, and Schwarz (2022) show that retail traders demonstrate the same type of biases found in earlier studies, whereas Welch (2022) argues for an overall good trading performance by retail traders. The partial answer to this incongruity may lie in the heterogeneity of retail traders. Eaton, Green, Roseman, and Wu (2021) find that properties of retail order flow are different for clients of different brokers. Overall, whether retail traders are informed or not remains an open question. While some studies show that retail traders generate positive returns (Boehmer, Jones, Zhang, and Zhang (2021)), others demonstrate that retail traders act more like noise traders (Peress and Schmidt (2020)). My findings illustrate that retail traders generate positive intraday returns on average, but this property is highly malleable and can be altered by gamification. As a result, retail traders act more noisily and contribute to market liquidity (Glosten and Milgrom (1985); Kyle (1985)).
The study also contributes to the literature that examines retail herding. Retail traders tend to trade in the same direction in response to market-wide events (Barber, Odean, and Zhu (2008); Barber, Lin, and Odean (2021)). Such a trading strategy creates additional inventory costs for market makers, who act as counterparties in these trades (Ho and Stoll (1981); Grossman and Miller (1988); Hendershott and Menkveld (2014)). The antidote to herding is noisier trades. For example, Cookson, Engelberg, and Mullins (2023) show that disagreement among retail investors leads to greater liquidity because such traders are relatively balanced on both sides of an order book. The current research indicates that gamification forces retail traders to act more noisily, which makes their order flow less toxic. In line with the theory of Baldauf, Mollner, and Yueshen (2023), market makers utilize this shift to improve exchange execution, as manifested in improved market-wide liquidity metrics.
This paper also discusses retail brokerage firms. In today’s market, they act as intermediaries between retail traders and wholesalers. The current practice, known as payment for order flow, allows brokerage firms to collect retail order flow and sell it to wholesalers for a premium (Easley, Kiefer, O’hara, and Paperman (1996); Battalio (1997); Bessembinder and Kaufman (1997); Comerton-Forde, Malinova, and Park (2018); Dyhrberg, Shkilko, and Werner (2022)). Then these orders are executed off-exchange (Menkveld, Yueshen, and Zhu (2017); Buti, Rindi, and Werner (2017)). Since the amount of the premium paid to brokerage firms depends on the traded volume they are able to collect (Bryzgalova, Pavlova, and Sikorskaya (2023)), it is in their best interest to maximize retail trading on their platforms (Egan (2019); Heimer and Simsek (2019)). To do so, brokers introduce new rational and behavioral features into their platforms. Two examples of rational features are zero-commission trading (Jain, Mishra, O’Donoghue, and Zhao (2020)) and fractional shares trading (Bartlett, McCrary, and O’Hara (2022)). In contrast, behavioral features include practices that increase the propensity of retail traders to execute extra trades, such as push notifications (Arnold, Pelster, and Subrahmanyam (2022); Moss (2022)) and gamification.
Gamification can be defined as “the use of game design elements in non-game contexts” (Deterding, Dixon, Khaled, and Nacke (2011)). It has been widely used in education (Caponetto, Earp, and Ott (2014)), business (Wünderlich, Gustafsson, Hamari, Parvinen, and Haff (2020)), and healthcare (Johnson, Deterding, Kuhn, Staneva, Stoyanov, and Hides (2016)) as a method to enhance performance in a given task. Whereas in finance, the only documented cases of the use of gamification are in the banking sector (Rodrigues, Oliveira, and Costa (2016); Baptista and Oliveira (2017)). This study contributes to the literature by analyzing how new game-like features, introduced by brokerage firms, affect their clients, i.e., retail traders. Chapkovski, Khapko, and Zoican (2021) conducted an experiment on traders using a trading platform with and without game-like features. Their study shows that gamification elements increase traders’ engagement, prompt them to take excessive risks, and conduct noisier trading. The results of this study confirm these findings in an empirical setting.
