The US Robinhood app is the most famous of the financial services that have changed the way people play on the stock market in recent months. Thanks to Robinhood, millions of small investors have had access to the markets for the first time, and according to supporters of the app – as well as according to the startup that owns it – this is a sign of democratization of a sector that is very difficult to access and which has always been dominated by professionals. For other analysts, however, apps like Robinhood have put too powerful financial tools in the hands of inexperienced investors, causing even serious damage.
Robinhood was created in 2013 by two Stanford graduates, Vladimir Tenev and Baiju Bhatt: the two decided to create an app capable of changing the financial markets after witnessing the Occupy Wall Street protests in 2011. The change has happened: Robinhood is It was the first service of its kind to eliminate stock trading fees. Before Robinhood, investors who relied on a broker to play on the stock exchange had to pay a commission for each transaction. Robinhood eliminated them altogether, bringing big changes to the entire industry: driven by competition from the app, the vast majority of brokerage firms within a few years eliminated the fees. Furthermore, on Robinhood, there is no mandatory minimum deposit to use the app, and you can also buy fractions of shares and thus make very small transactions, from a few dollars.
Robinhood was successful early on, but there was a huge increase in new enrollments in the spring of this year, during the coronavirus pandemic lockdown: in March, an average of 4.3 million were made on Robinhood. transactions per day, much more than historical and famous brokerage firms such as Charles Schwab or E-Trade. Robinhood now has 13 million users, and this year alone has added 3 million. The median age of users is 31.
In the same months, the fashion for brokerage apps spread around the world. In Germany, for example, the Trade Republic app, which offers Robinhood-like services, saw an increase in traffic that a spokesperson described to Bloomberg as “exponential”. In the UK, between April and May, the opening of new investment accounts of the online brokerage service Interactive Investors has increased 163 percent for investors aged 18 to 24 and 238 percent for investors aged 25 to 34. In India, the Zerodha trading app is having such success that the two founders, Nithin and Nikhil Kamath, they have just entered on the list of the 100 richest people in the country made by Forbes (in 90th place). In Malaysia, small investors are one of the causes of exorbitant increases (even 1000 percent) of the securities of companies producing latex gloves (the coronavirus also has to do with it, of course).
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The reasons for this increase in transactions mainly concern the lockdown: hundreds of millions of people around the world found themselves at home, some without work, and searched for an easy way to make some money. In some countries, such as the United States, it was also influenced by the fact that, thanks to government aid, for a few months many people had an income higher than usual, and therefore more money to invest. Today, individual investors, that is, individuals who invest their money on the stock market, make up 20 percent of the market, and have growing weight and influence.
However, Robinhood remains the most famous app, the one that gave rise to a new phenomenon, and its success is one of the reasons it is the subject of much controversy and controversy. Robinhood’s interface is clean and cheerful, and making transactions is so easy that some critics have begun to say it might be too easy: in a few minutes anyone can open an account and start betting on the stock market, without preparation and without restrictions. Robinhood has been criticized for having “gamified” the game on the stock exchange, that is, for having included some typical video game features in its app to make its use more fun and keep users engaged. For example, each user is assigned a level which corresponds to the possibility of doing more or less complex operations. The more the levels increase, as in video games, the more new functions are unlocked, which usually correspond to riskier transactions.
Robinhood also uses many “behavioral nudges”, that is, incentive and reward systems (nudge stands for “nudge”) which are usually applied by social network apps to be more captivating: the app gives some action when signing up, sends funny notifications full of emojis, and when a user passes the screen fills with confetti.
Robinhood has received many attacks when investors using the app have made transactions that professionals consider to be high risk. For example, this spring, thousands of users began buying Hertz stock after the rental car company went bankrupt and its value plummeted to 40 cents a share on the stock exchange – the shares were very cheap and Hertz is a well-known name that has attracted inexperienced users. The stock recovered a lot of value thanks to individual investors, but professionals considered it a high-risk move, also because in those months it was feared that Hertz could withdraw completely from the financial markets.
The worst scandal for Robinhood was in June, when Alexander E. Kearns, a 20-year-old from Naperville, Illinois, committed suicide and left a note on his computer saying he did it because playing on the stock market with Robinhood he had accumulated a debt of $ 730,000. In the note, Kearns wrote “I had no idea what I was doing” and that it was not his intention to do such risky operations. Kearns was buying and selling options, which are complex and risky financial contracts for a beginner. The story escalated for Robinhood when it was discovered that, as far as options work, the $ 730,000 loss was only temporary, and that Kearns would likely recover much of that sum. The founders of Robinhood they said to each other “Personally devastated” and promised improvements and more clarity.
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It is still unclear whether Robinhood’s individual investors are really more reckless than the professionals, indeed. A study recently released, published by a professor at the University of California, Los Angeles (UCLA) and entitled “Retail Raw: Wisdom of the Robinhood Crowd and the Covid Crisis” says that “the narrative of a pure and irrational exuberance” in investing in Robinhood “It is misleading”. The study analyzes transactions made on the app between mid-2018 and August of this year, and argues that overall Robinhood’s user equity portfolio has beaten the market (i.e., it has outperformed the stock market. ) and did better than some very famous equity funds. Another study released this summer it says something similar, albeit using a different methodology: “Investors on Robinhood bought riskier stocks, but they also did slightly better than the market.”
Another problem for Robinhood is that the SEC, the US stock exchange authority, in September opened an investigation on the app because it hasn’t clearly told its users how it makes profits. Having eliminated transaction fees, Robinhood uses a practice that the Wall Street Journal defines “controversial but legal” and which is called “payment by order flow”. Basically, when a user buys a stock on Robinhood, the app doesn’t execute the transaction. Robinhood sells the user’s order to other companies who call themselves “market makers” and who make money by reselling and buying shares in bulk at slightly cheaper prices (we are talking about a few cents per share). In order for both Robinhood and the market maker to make money, orders placed on Robinhood are slightly more expensive to the user than they would be elsewhere (again we are talking about a few cents per share). According to the SEC, payment by order flow is a practice that can save small investors, but must be made public by the broker. Robinhood faces a $ 10 million fine.