Not all dangerous trading comes from insider trading practices, fraud or false and misleading information. Social media and tech platforms can also cause people to engage in risky trading, a new study by Purdue University’s Mohammad Rahman, the Daniels School Chair in Management, demonstrates.
When Yahoo! abruptly shut down its free Finance API on November 1, 2017, without any official announcements or reasons, longtime retail investor users were left without clear alternatives. The widely popular service had provided institutional investor-grade real-time stock quotes, historical data, and financial news for stocks, bonds, currencies, commodities, and indices. Institutional investors pay significant amounts to get access to such data and utilize them for trading advantages. Interestingly, in the period in which retail investors were searching for suitable free/cheap comparable alternatives, they changed their gambling-like behaviors in making investments, the study found.
The study, co-authored with Taha Havakhor (McGill University), Tianjian Zhang (California State University, Dominguez Hills) and Chenqi Zhu (University of California Irvine), is forthcoming in Management Science. It notes that the Yahoo! Finance API gave retail investors access to huge data sets that the self-taught investors potentially mined for information using code from Github. With tutorials from YouTube, they could create models to draw insights, often flawed. Without understanding the technology’s limitations and the data’s historical context, these investors equated their knowledge with expertise, leading them to invest and trade overconfidently.
“People who don’t know how to consume, process or apply the data in the context in which it sits end up losing immense amounts of money and skew stock values using the technology,” says Rahman.
While Yahoo! API was up and running, untrained investors felt they’d overcome their informational disadvantage, giving them the illusion of control, because they personally involved themselves in the decision-making without realizing how the technologies might amplify deficiencies while mining the data, modeling, and drawing insights from it.
“They uncover inaccurate patterns in the data and equate the patterns with knowledge, thus believing themselves to be more knowledgeable than the average investor. Access to huge data sets gives them a sense that they are more precise, when in fact, their errors in interpreting the data reduce their accuracy,” says Rahman. Cognitive biases noted in the study – an illusion of knowledge, control, and precision – have been broadly discussed in media and haven’t led retail investors to recognize flaws in their investing, which Rahman says raises key policy questions about unregulated sources of data.
Where investment firms pay thousands of dollars to obtain up-to-the-minute data and employ highly trained teams of analysts, individual retail investors fall prey to meme-stock trading schemes, rely on “spurious” patterns, and use fintech with negative outcomes for themselves and the markets.
It’s time for the U.S. Securities and Exchange Commission (SEC) to adapt, Rahman believes. At present, the SEC’s mission is “to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation” through the setup of financial institutions, fiscal measures, public borrowing, and the development of capital and secondary markets. The commission has a mandate to enforce regulations against insider trading, accounting fraud and false or misleading investment information. Just as Congress and Artificial Intelligence tech leaders are holding necessary conversations about AI technologies, Rahman believes policymakers should discuss the mandate of the SEC to fulfill its mission regarding fintech, especially in the rapidly evolving environment.
Rahman says that regulators should be thinking more broadly about information sources, what can influence investors, how to safeguard retail investors, and how to challenge tech companies about their responsibilities. How are companies influencing markets and regulating themselves? What ethical guidelines should they put in place before the SEC vets even more stringent ones?
As analysis published by the International Monetary Fund notes, big tech companies house so many entities where one division’s goals may be at odds with another’s, they’re often hard-pressed to police themselves, especially in the murky realms where the SEC and global monetary regulators do not yet have the mandate to regulate.
Rahman says that there are two paths: either big tech and fintech companies step forward to recognize their role in creating system-wide vulnerabilities in the markets and for consumers by providing access to technologies and data most retail investors do not adequately understand, or policymakers will need to weigh the benefits and downsides of sprawling and seemingly unrelated technology products.
Since 2017, persistent retail investors have found workarounds. Financialmodelingprep.com lists 11 alternatives while marketdata.app continues to provide guidance on how to use Yahoo! Finance’s historical data for free even in 2023.
“We need to begin to have conversations about regulating such flow,” says Rahman.
