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How to protect your family against social media sites encouraging Reckless Trading

How to protect your family against social media sites encouraging Reckless Trading

April 13, 2021

Since April is Financial Literacy Month, it's the perfect time to address a current issue. Online trading has become more risky due to the advent of Robinhood, Reddit, and other social media sites. While the GameStop stock trading made it famous, there are real consequences to risky trading. 

How Online Trading Has Become More Risky 

Online trading has become society’s newest form of gambling for young adults in our society. This is in part due to the rise of commission-free trading by brokeragesThe growth of social media, and the higher potential for influencers to make money from their followings has also played a role in encouraging risky, reckless investing behavior.  

This has elevated the role of trading from a hobby or pastime to an activity with the potential to ruin a person’s financial future – and in some cases, it unfortunately has. 

For these reasons, I encourage you to pass the following information on to your children, any young adult you know, or any individual that you know who may be participating in online trading. You may also refer them to the sources listed at the bottom of this article for further explanation of the concepts discussed. 

How online influencers make money and the potential bias that goes along with it 

Social media influencers are not always objective in their views. For all of the following reasons, recommendations made on the internet may be highly biased to benefit the person making the call, and should not be assumed to be objective, independent, or made 100% in your favor. 

  • Social media influencers are motivated to talk about controversial topics or make exaggerated statements to attract attention and grow their followings. Many of them get paid advertising revenue for views on their posts.

  • Influencers may also earn money by encouraging their followers to buy products that they receive an affiliate payment on through use of affiliate links. Someone may say, for example, to click a link below their video to open an account at a certain brokerage firm for a discount. The below screenshot shows an example of affiliate marketing. The below image clearly asks the viewer to open a specific account, which the influencer is paid to promote. 

  • Influencers may also benefit from you taking action on certain positions that they hold or intend to get involved with. If they hold a certain stock, they stand to benefit from massive buying action taken by others on the same position.   

  • Influencers may neglect to fully disclose all of the risks involved with making the investment in an effort to prompt followers to take action. 

  • They also may cite impressive historical track records without providing legitimate verification of these performance results 

 

Often these influencers do not conduct proper research and are not licensed, regulated, or registered representatives of any securities firm. As a result, they are given significantly more freedom to discuss high risk recommendations without having to fully disclose the potential downside of any investments they are recommending. 

 

Margin, shorting and unlimited potential for loss 

Certain brokerage positions may offer you margin as a way to potentially magnify the gains made from trading.  Trading on margin is a high-risk activity and you have the potential to lose substantial amounts of money if the market moves against you. Margin is defined as money borrowed from the brokerage firm you are trading with. In essence, you are getting a loan from the broker, one that is not forgivable under any circumstances and that you must pay interest on. Please refer to this description of how margin works from Charles Schwab.           

 

Short selling is a high-risk form of trading. You borrow a stock on margin and then sell it, with the understanding that you will buy it back. Your hope is that the stock drops in price so that you can profit from the difference between what you sold it for and what you bought it for. Because stocks have the potential to rise indefinitely in price, the potential for loss on a short position is unlimited. Please let your family know to take precautions and understand the risks of short selling before doing so. 

 

Responsible trading tips 

  • Before you take advice from someone on the internet making an investment recommendation, ask yourself what they stand to gain by you taking the action they recommend. 
  • Conduct your own research and consult numerous information sources with varying and opposing opinions. 
  • Take the highest of precautions when investing in speculative stocks, engaging in short selling, or trading on margin, as the potential for loss is high and, in some cases, may be unlimited. 
  • If you have any questions about what you are trading, stop and consult a qualified, licensed, and regulated financial professional before going through with the trade. 
  • Always consider the maximum potential for loss and thoroughly research all of the risks involved before initiating any trade. 
  • Do your research before trading on stocks, especially popularized stocks like GameStop (GME) or Dogecoin.

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Sources 

Chang, Charlie. (2021, Jan 28th). The 6 TOP Stocks To Buy in February 2021 (High Growth). Retrieved from https://www.youtube.com/watch?v=Hz6EU_e34iI&t=10s 

 

Frederick, Randy. (2021, February 12). Margin: How does it work? Charles Schwab. Retrieved from https://www.schwab.com/resource-center/insights/content/margin-how-does-it-work. 

 

Little, Ken. (2020, January 19th). Short selling stocks – not for the faint-hearted. Retrieved from https://www.thebalance.com/short-selling-stocks-not-for-the-faint-hearted-3140549 

Singh, Manoj. (2021, Jan 9). Investopedia. How to become your own stock analyst. Retrieved from https://www.investopedia.com/articles/basics/09/become-your-own-stock-analyst.asp