Robinhood

As legend goes, Robin Hood was a medieval outlaw who would battle authoritative figures and steal from wealthy landowners whilst distributing his ill-gotten booty to the commoners. Today we have Robinhood, an app that may do just the opposite..

Commission-Free Trading?

I’ve been trading stocks long enough to remember getting excited when a trade was only going to cost me a flat $24.95. Talk about an incentive for buy-and-hold investing! Trading these days is a very inexpensive prospect in comparison. Over time I’ve seen $12.95 action eventually decreased to $4.95 action at Charles Schwab, who now offers commission-free trading for a plethora of ETFs. I also have an account at Interactive Brokers that executes stock trades for $0.005/share with a $1 minimum and a max of .5% of the total trade value.

Along comes a new app that now allows me to trade stocks for free. Free? Commission free? Enter Robinhood… There’s a catch, right?

Robin Hood
Our Hero!!!

For me, when I see these free or freemium “lack of a product” companies like Robinhood, I immediately begin to suspect (rightfully so) that *I* am the product. Why is Facebook free, or the Google search engine, Gmail, and Snapchat? They’re free because *we* are their product, voluntarily (and maybe unknowingly) exploited in various ways for the benefit and monetary gain of these platforms. Help us Robin Hood!

Considering Robinhood:

First and foremost, the studies have been done, the Nobel Prizes have been awarded, the math has been proven, and the books have been written. It is going to be very, very difficult for you to outperform a market index over the long term of your trading “career”. You’re going to be better off paying .1% per year, buying some broad-market index funds, setting up some auto-draft contributions from your checking account, and not opening your statements until you’re ready to retire.

S&P500 index vs. hedge funds
A sample of a long-term 22 year performance – the S&P500 index vs. hedge funds

Successful investing really is that easy and you’ll outperform a vast majority of all the professional investors, hedge funds, and advisors net of their fees by inexpensively indexing various market sectors. Furthermore, with the ETFs I can buy & sell at Schwab commission free, Robinhood provides no cost advantage with that proven strategy.

Getting Slaughtered:

A commission-free stock trading platform on an iPhone is going to lead to folks buying stocks they know nothing about when they don’t know how to size their allocations, don’t know their edge (or lack thereof), don’t know how to evaluate the value of what they are buying, and don’t know what their risk factors may be.

Buying individual stocks when you don’t know how to even do a simple valuation of a company’s earnings report is a bit like taking a guy who has mastered Go Fish and plopping him down at a poker table at the Bellagio and saying; “don’t worry, they won’t charge you anything to play poker, just go buy some chips and make some money like they do on tv.”

Slaughter House
The Robinhood trading desk a mere 6 months after the Snapchat IPO as SNAP goes from $29/sh to $11/sh

Free trading may also lead to the notion it is “risk free” trading. There’s something about that “free” moniker that is a very powerful persuader in people. It leads to folks buying and selling way too often as they try to time the market. I also see people executing trades on Robinhood when they have no idea what the company does or even what sector it serves – no, no, and no. Launching Robinhood in the midst of the red-hot stock market we see today may only serve to give folks a false sense of security.

Oddly, Robinhood offers no tools for even a rudimentary analysis of a stock’s price, performance, or valuation metrics other than a 1 year price history – wholly irrelevant absent a host of other metrics. A lack of quantitative financial information means folks will be trading on rumor, soundbites, social media ideas, “hot tips” from their friends, and possibly darts thrown at a dartboard. Geez, you’d think Robin Hood would lend you a few arrows from his quiver to give you the best edge possible before you enter the battlefield, but no…

Taking A Beating:

Buying a stock on Robinhood literally takes 3 taps on your iPhone’s screen – fewer clicks than it takes to fire up a game of Words With Friends. Why the FTC fears online poker or football betting websites but allows Robinhood to launch and prosper is beyond me!

After a day of heavy trading
The aftermath of a busy trading day on the Robinhood app – photo by Andrew Yardley

As if irrational exuberance in stock trading wasn’t enough, let’s amp it up with  Robinhood Gold, shall we? For $10/month ($120/year) this “freemium” service will let you trade with 2x leverage (borrowed money) and also let you trade in the After Hours Market (where pimps and thieves run free).

The minimum Robinhood balance for Robinhood Gold is $2,000. Paying $120/year on a $2,000 portfolio means paying a 6% yearly cost for the pleasure to invest after-hours and with 2x leverage. That is an insanely high operating cost on an investment account! That 6% is going to be a huge hurdle to overcome in order to generate returns over the stock market as a whole. For perspective you could invest $250,000 into index funds for that same $120/year in management expenses. Help us Robin Hood, this is highway robbery!

So How Does Robinhood Make Money?

Robinhood’s website explains the two ways their company makes money – one, cash that sits in your account earns interest for Robinhood.  Two, the Robinhood Gold fees + the juice on your leverage. Simple enough, right? I see two problems:

Problem one – Letting my cash earn interest for other people? No bueno. Think about it – Robinhood’s success is inversely correlated to your success. More cash stored in your account means Robinhood makes more money; however, that is interest you are losing out on and opportunity costs you are absorbing by not having that money invested and earning money elsewhere. You’d think Robin Hood would extract as much money as possible from the big bad banks and provide a lowly trading serf with the highest interest rate he could muster, but no…

Problem two – Any losses you experience will be amplified as you trade with borrowed money that turns a profit for Robinhood –  their success depends upon you borrowing money to trade with, thus exposing you to greater aggregate losses. You’d think Robin Hood would fight to protect your downside and ensure the big bad banks don’t expose you to losses that could exceed your initial investment, but no…

robinhood

Hold The Phone…

The website fails to mention a third and very important way Robinhood generates revenue – one that concerns me the most. Curiously missing from its website is the disclosure that Robinhood receives payments from the 4 market centers in which they route your trades. Remember, YOU are the product here…

Robinhood receives payments by routing your trades through firms with high-frequency trading arms – Apex (KapGen), Citadel , KCG (Virtu Financial), and Two Sigma. These are algorithmic trading outfits that churn out millions of trades per day and make money by capturing small price discrepancies in the bid/ask prices. These spreads are small, but via their ultra-high volume they churn out very large profits.

For a fascinating look at algorithmic / high-frequency trading explained in such a way that anyone who can read a book can understand and enjoy the story immensely, Michael Lewis’ “Flashboys” is a must-read!

I wonder why this revenue stream is not listed in the “how does Robinhood make money” section of their website, but found only in their legally required SEC disclosure? It seems a bit disingenuous to me that they represent their revenue stream to their customers differently than what they lay out for the government in their federally mandated filings. You’d think Robin Hood would disclose all of his revenue streams to his customers, especially the streams that may exploit customer trades and sell them as products to other financial firms, but no…

Squeezed?

When you are trading you probably don’t want your trade peeked at by someone who could act as a counterparty – that someone could push up their offer price a bit and skim a little money off your side of the trade, right?

Does Robinhood front-run your trade to these 4 firms in exchange for their payments on that action? And then do these firms use their high-frequency algorithms to squeeze you on your side of the trade as they represent parties paying them on the other side of transaction? Do these firms have access to Robinhood’s API to exploit your trade for their benefit? Remember, YOU are the product here – that is why I ask, but what else would these firms be paying Robinhood for? Robin Hood, why do these firms pay you for your order flow?

Slippage:

The difference in the price of your trade at the order and the actual cost of the trade at its execution is called “slippage”. Larger trading firms will most likely be very efficient and more apt to trade at the best possible price with little slippage. If Robinhood’s bid/ask spreads are prone to high levels of slippage, and I suspect they are, then depending upon the number of trades you make and the dollar amount of your trades Robinhood users may be better off simply paying a small commission at a discount broker rather than trading on a platform with a high degree of slippage. Robin Hood, free isn’t always without cost, right?

Should You Trade on Robinhood?

Believe or not, I do… Call me duplicitous but I trade what I call a little of my “Vegas Money” there. I also enjoy their referral program where Robinhood gives us BOTH free shares when you sign up using my link. This link. THIS IS MY LINK.

So far I’ve received multiple free shares of AMD, Chesapeake Energy, Ford, Sirius XM, and Zynga. As soon as the promo is over and they’ll let me do an asset transfer of those free shares into my “real” brokerage account where I keep my other investments, I’ll delete the app.

In the meantime I play with some very volatile ETNs (don’t ask…) that I like to day-trade for fun. This is an easy to do that while I’m on the toilet going poo-poo. Thanks Robin Hood…

the casino is open
The casino is open!  – photo by William Fitzgibbon

Caveat… my account is small (<1% of my total investment allocation), I keep no cash there, I do not pay for leverage, and I would never consider nor recommend this as a primary trading, saving, investing, or financial platform. It’s amusement – like an online poker game, or betting on football. Nothing more. If I lose this money I don’t cry at night and the babies still get fed.

Conclusion:

I would imagine many folks will lose money on Robinhood. Some unlucky ones will really get banged up, scarred, and flattened. Some lucky ones will hit big and be smart enough to extract their winnings, walk away, and get into more sensible and proven investments – those are the ones we’ll be reading about in the news…

It’s just too easy to find a broker that will help you open an account for free, let you trade sensible and proven investments for free, pay you interest on the cash in your account, and give you research & analysis tools to help you understand & value stocks, bonds, and the market as a whole. Thanks, but no thanks Robinhood.

The views expressed here are my own opinions and not representative of my employer, Apple Inc. This blog should in no way be construed as a recommendation to buy any particular security or invest using any particular trading platform. Do your own due diligence when investing & consult the services of a fee-based non-commissioned professional as necessary.

 

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