The numbers were staggering. Robinhood’s average daily trading volume tripled in the first quarter of this year, compared with the last quarter of 2019, and saw a tenfold increase in net deposits as millions were losing their jobs. The New York Times reported that the firm in the first quarter traded nine times as many shares as E-Trade, and an incredible 40 times as many as Schwab. It added 3 million new customer accounts, and by June was doing 4.3 million daily average revenue trades, or DARTS, more than any other online firm and more than Schwab and E-Trade combined.
Analysts saw nothing but conquest ahead. “Competing versus Robinhood will be difficult,” said Larry Tabb, head of market structure research for Bloomberg Intelligence.
Robinhood seemed a new prodigal son of 21st-century capitalism, an awesome hybrid of Wall Street and Silicon Valley. The firm combined the pure greed of a Goldman, Sachs or JP Morgan Chase with the cheery, youth-friendly user-engagement strategies of Instagram or TikTok.The firm was founded in 2013 by two perma-smiling Stanford grads named Baiju Bhatt and Vlad Tenev, who wore khakis and Monkees haircuts and never seemed more than a moment away from bro-hugging one another.
These harmless-looking eggheads sounded genuinely excited to bring their product to the world, explaining they had a mission to “democratize finance for all.”
The app is perfectly designed for such “democratization.” It’s free, charging no commissions for trades. It also has an alluring, Joe Camel-like marketing campaign, featuring a host of bells and whistles in the form of free sample share giveaways, “scratch-off” rewards, and video confetti to celebrate transactions. “Even the most skeptical investor can be drawn in,” is how Jason Zweig of the Wall Street Journal just put it, describing how an assignment to learn more about the Robinhood experience led to something like addiction in less than a week.
Small-time customers who can’t afford a whole share of, say, Amazon stock can buy fractional stocks, and can also engage right away in complex options bets, just like the pros! What Bloomberg called “stock trading on a fun gamelike phone app” brings hordes of rookies into the markets: half of Robinhood’s customers this year were first-time traders, and 80% of its assets under management belong to millennials.
The firm is an icon of success in the pandemic age, finance’s answer to Netflix and Amazon Prime. Without sports to bet on, or bars to crawl, a whole new generation of “investors” are making Robinhood the destination for the ultimate new Covid-19 addiction: binge-trading. What could possibly go wrong with bringing more people into the stock market?
A lot, as it turns out. “Every time someone says they want to ‘democratize access,’” says Joe Saluzzi of Themis Trading, “I get very scared.” (...)
In what the press accounts describe euphemistically using terms like a “controversial but legal practice,” Robinhood makes the bulk of its money on “payment for order flow.” It sells its data to high-frequency traders like Citadel and Virtu, market makers who ostensibly are paying for the honor of executing trades for Robinhood investors. These firms, using the technology that’s the subject of the celebrated Michael Lewis book Flash Boys, hunt out tiny price differences and gauge market sentiment and supply and demand before other traders, using sophisticated algorithms to jump ahead of the pack.
A Robinhood investor typing in a trade is just beginning a series of transactions that might result in a string of actors being compensated. Robinhood does not and can not post orders directly to exchanges like the NASDAQ; for a fee, it sends all of its orders to market maker firms like Citadel or Virtu. Those firms in turn have what amounts to a free option on the Robinhood trader’s order. They can execute the trade themselves, or they can offload it to an exchange, which in turn posts the order and compensates the market maker firm in the form of rebates, while earning money itself by charging fees for “data feed” that include information about such retail orders.
The mechanics of all of this are not absolutely necessary for Robinhood customers to understand, but it is worth asking the question of whether all of these actors in between the Robinhood client and his or her trades withdraw more or less value than, say, traditional broker fees. The HFT firms that handle the bulk of Robinhood’s business have always maintained that what they do is socially beneficial, because their trades “add liquidity” and make markets more efficient. Critics say the opposite, that high-speed algorithmic trading is just using advance peeks at market intelligence to turn trading into a low-risk arbitrage-like activity. (...)
The obvious problem is that a lot of these younger customers have no clue what they’re doing. “Retail investors don’t understand stocks, let alone options,” sighs Saluzzi. He compares the service to bringing amateur poker players to Vegas and seating them not at a table with old ladies and tourists, but with the best players in town. “It’s throwing them right in with the sharks,” he says.
by Matt Taibbi, TK | Read more:
Image: uncredited
