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The suicide of Alex Kearns — who thought he had lost heavily — has triggered calls for reform of online brokerages
Robin Wigglesworth in Kragero, Richard
Henderson in Melbourne and Eric Platt in New York
JULY 2 2020
Alex Kearns was an ordinary 20-year-old. He
played the trombone, studied at the University of Nebraska and, like millions
of other Americans, traded stocks to pass the time or make some money when
coronavirus shut down schools and workplaces. Unfortunately, his youthful
dabbling ended in tragedy.
On June 12 back at home in Naperville, Illinois, Kearns took his own life, after believing he had lost nearly $750,000 in a soured options bet made on Robinhood, an online brokerage that has become emblematic of a new era in retail investing.
In a note left for his family, Kearns said he had “no clue about what I was doing” and never intended to “take this much risk”. Horrifically, it appears Kearns mistook the potential loss on one leg of an options trade for the outcome of the overall bet — wrongly believing that he had racked up a loss of $730,165. In fact, his account had a balance of $16,000.
The tragic episode highlights the dark side of the recent boom in retail trading and the offerings from online brokerages — such as free trading, options, cheap debt and the ability to buy small slices of stocks — which have lured more investors to the markets. Some observers worry the new class of e-brokers have helped turn the experience into something akin to a video game, with constant updates about profits and losses and social media fuelling the frenzy.
“The more I dug into it, the angrier I got,”
says Bill Brewster, an analyst at Sullimar Capital in Chicago who is married to
Kearns’ cousin and speaks on behalf of the family. “They’re almost pushing
people into financial dynamite.”
The surge in retail trading has been a boon
to brokerages. Robinhood added 3m users in the first quarter, pushing its total
number of users above 13m. Schwab, ETrade and Interactive Brokers together
added 1.5m new accounts in the first five months of the year, nearly double the
amount for the same period in 2019. TD Ameritrade, which shares quarterly data,
added more than 500,000 new accounts in the first quarter — three times the
amount for the same period a year earlier.
Vlad Tenev and Baiju Bhatt, the co-founders
of Robinhood, said they were “devastated” by Mr Kearns’ death, and vowed that
the company would expand educational resources related to options trading,
tweak the app to clearly show users’ financial exposure when making options
trades and would consider adding new criteria for customers to trade
sophisticated options.
Congressman Sean Casten of Illinois last week
raised the tragedy with Jay Clayton, the head of the Securities and Exchange
Commission, who said regulators were looking at how to improve disclosure. “I
read it over the weekend and it’s terrible,” Mr Clayton said. “We need to do
something to make sure these kinds of things don’t happen.” Mr Casten later
tweeted: “Democrat or Republican, Alex could have been any of our kids. It’s
time for the Senate to act.”
Mr Brewster lauds the changes promised by
Robinhood, but remains worried about how it and other platforms have
transformed trading and sucked in younger, inexperienced and potentially
vulnerable people.
“It’s the beginning of a long journey, not
the end,” Mr Brewster says. A broad discussion is needed about the downsides of
giving everyday investors unfettered access to the markets, he adds. “Have we
crossed the Rubicon into dangerous territory? I think we probably have.”
SEC chairman Jay Clayton testifies last week before the House Committee on Financial Services hearing, ‘Capital markets and emergency lending in the Covid-19 era’. He said regulators were looking at how to improve disclosure © Rod Lamkey/Getty
Video game Icarus
Berkshire Hathaway’s famously acerbic
vice-chairman Charlie Munger made his views on day traders and their enablers
clear at last year’s annual meeting of the Daily Journal, the publisher he
chairs.
“I regard that as roughly equivalent to
trying to induce a bunch of young people to start off on heroin,” he told the
attendees. “It is really stupid.
” Mr Munger was not far off. Research by
neuroscientist Hans Breiter shows the same part of the brain activated by drugs
like cocaine is also triggered when a person anticipates a financial gain. That
has been supercharged in the new era of online trading platforms.
The neon colours and slick interface of
Robinhood, as well as its pitch to users to “level up with options trading”, is
a step change from the relatively sedate websites of its older rivals such as
ETrade and Charles Schwab. New users are given a free stock — usually valued
below $10 — to get them started, and confetti blasts across the screen when
users make their first stock and option trades.
“The parallels between video games and day
trading is becoming closer and closer,” says Andrew Lo, a finance professor at
Massachusetts Institute of Technology. “For many gamers, particularly the
younger ones who are not used to trading and don't fully understand the impact
of significant losses and gains on their psychophysiology, it could have some
significant adverse consequences.”
According to Prof Lo’s studies of traders,
the consequences include fear, anxiety, regret, frustration and disappointment,
and even symptoms of post-traumatic stress disorder for those who made large
losses early in their careers.
Vlad Tenev and Baiju Bhatt are co-chief executives and co-founders of Robinhood Financial
© Alex Flynn/Bloomberg
The ‘gold’ membership allows traders to make bigger bets with money borrowed from the company © David Paul Morris/Bloomberg
In the past, getting signed up to an online
brokerage could be fiddly and take time. But the technology has moved on and
today, it can take just minutes to sign up for an account in the US. Broker
approval usually takes a day, opening the door to trade in stocks and exchange
traded funds. Traders can then seek approval for more advanced instruments,
such as options or borrowing money on “margin”.
For example, Robinhood traders can sign up to
its “gold” membership, which costs $5 a month after a free 30-day trial. This
allows traders to make bigger bets with money borrowed from Robinhood. The only
restrictions are that federal regulations require a trader to have at least
$2,000 in their brokerage account and “a suitable investment profile in order
to use margin”, which Robinhood determines with a few questions on the trader’s
experience, aims and sensitivity to risk.
Analysts say the use of options can be
particularly dangerous. Options are a financial derivative that can give
investors far greater exposure to a stock or equity index falling or rising
with an often minimal downpayment, magnifying gains but also potentially
enhancing losses.
The retail trading frenzy has already helped
trigger a surge in option trading this year, with the total value of contracts
now at $5.2tn, roughly double the level seen five years ago, according to
Goldman Sachs. That is a sum equal to about 20 per cent of the overall stock
market value of the S&P 500 benchmark of US blue-chip companies.
Researchers at Allianz, the German insurer,
noted that single contracts — most popular with smaller individual traders —
accounted for 13 per cent of S&P 500 options volumes traded since March, up
from about 8 per cent a year earlier. For some stocks popular among day traders
— such as Chipotle, Amazon and Tesla — single contracts account for between 20
per cent and 30 per cent of the option volume.
“One only has to spend some time on popular
Reddit communities to get a broad idea of the current market hysteria and the
risks that ‘new retailers’ are taking,” Allianz said in a report in June.
Bill Brewster lauds the changes but says ‘it’s the beginning of a long journey’
The e-brokers have statements stressing that
options trading entails significant risk and is not appropriate for all
investors, directing people who want to learn more to a 26-year-old paper —
last updated in 2012 — from the Options Clearing Corporation about the
potential pitfalls.
Retail brokers are required to set different
levels of options trading available to customers, who apply for permission to
move from one tier to another based on factors such as how long they have
traded, net worth, liquid assets and age. The e-brokers typically have
three or four different levels but do not disclose the requirements for each
tier to avoid users gaming the system.
The brokerages are also subject to rules that
require investors classed as day traders, under a regulatory definition of four
trades in and out of a stock in one day across five trading days, to hold at
least $25,000 in equity in their accounts. Brokers said in statements to the
Financial Times that they adhere strictly to regulatory guidelines, ensure that
only suitably experienced traders can get access to more complex option
strategies, and provide plenty of free education for traders.
The neon colours and slick interface of Robinhood, as well as its pitch to ‘level up with options trading’, is a step change from older rivals’ websites © Andrew Harrer/Bloomberg
The company vowed to tweak the app to clearly show users’ financial exposure when making options trades © Andrew Harrer/Bloomberg
The retail trading phenomenon has been so
strong that even professional investors have had to adapt to its warping
effects. Max Gokhman, head of asset allocation for Pacific Life Fund Advisors,
a US fund manager, says he has now been forced to consider the impact of retail
trading in companies that have become popular among everyday investors — such
as airline stocks and Tesla.
Mr Gokhman likened professional investors to
pilots manning a jumbo jet, while the retail traders are Icarus, the mythical
Greek figure with wings of wax, flying alongside. “We know we can move altitude
up and down and have sophisticated systems to change our exposure,” Mr Gokhman
says. “But Icarus is just getting higher and higher, closer to the sun and
inevitably Icarus — in this case the day traders — will crash.”
Options risks
Even some veteran day traders are shocked at
the current frenzy. Marcello Arrambide, who runs Day Trading Academy to train
and funnel promising stock jocks to his trading platform SpeedUp Trader, thinks
that the current market euphoria, and the day-traders it has buoyed, will end
in tears.
“The barriers are now so low that anyone can
come in and think they can do it. You can’t lose right now, and that’s the
problem,” he says. “The amount of people that are going to get wiped out when
the market does fall is going to be ungodly.”
Mr Arrambide refuses to teach traders to use
options, preferring to concentrate on stocks and futures, and is in favour of
restrictions on their use for retail investors, given the complexity and
potential pitfalls. “But if it isn’t trading, it would be something else,” he
adds. “People just want to get rich quick.”
Terrance Odean, a finance professor at the
University of California at Berkeley who has studied day traders, says more
education is needed. “If it’s play money and money you can afford to lose,
that’s your business. But you don’t commit suicide because you lost your play
money,” he says. “I would hope the vast, vast majority of investors writing
unhedged calls and puts understand the risk but I assume there are some who
don't . . . it wouldn’t be horrible to give people five minutes of education.”
Study after study in various countries
demonstrate that the overwhelming majority of day traders end up losing
money.
A recent study of retail investors in Brazil
between 2013 and 2015 found that 97 per cent of those that traded for at least
300 days lost all the money they had put up. Only 1.1 per cent made more than
the Brazilian minimum wage, and only 0.5 per cent earned more than an
entry-level bank clerk.
The impact of trading on people’s health can
also be marked. Big stock market drops are associated with worsening mental
health, spikes in binge drinking and fatal car accidents involving alcohol,
according to a study from the University of Chicago.
Trading may seem like a sedentary job, but
the stresses can even have physiological effects, such as higher blood
pressure, Prof Lo says.
“Trading is a physiologically taxing
activity,” he says. “You may not think that, because what are you doing?
Sitting at a desk and shouting numbers into a phone or entering orders
electronically. But the amount of stress that trading imposes on the human body
is very significant.”
Family left with questions
Mr Brewster says none of the family are aware
of any other underlying reasons why Kearns might have chosen to take his life.
He had previously known the young student as someone who would always play with
everyone’s kids at family gatherings, but in March he had approached Mr
Brewster to talk about stocks, the Federal Reserve and the outlook for the
economy.
“It seemed like his life was in a good spot . . . It
was the first time we really talked as men,” he says. “Now we’ll never be able
to do it again.”
There are not thought to have been any other underlying reasons why Alex Kearns might have chosen to take his own life © Kearns Family
The loss has galvanised him, and he now wants
to spark a broader debate about the side-effects of gamifying trading that have
emerged as the dark side of “democratising” investment, as proponents frame it.
The Kearns tragedy may be uniquely awful but Mr Brewster frets that the
problems he faced will be far from uncommon, given the recent day trading
frenzy.
“I think people are making massive mistakes
and ruining their financial futures,” he says. “The societal consequences could
be huge down the line.”
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