Moving fast and breaking things is a hallmark of disruptive companies and one that honors investors during the current bull market.
For Robinhood, Silicon Valley’s online trading platform with its super accessible and seductive app, disruption has collided head-on with the backrest that protects the financial system.
In the wake of rising customer trading volumes around GameStop and other hot stocks, Robinhood was forced to raise $ 3.4 billion in two separate capital injections within days.
Supporters, led by Ribbit Capital, certainly expect the brokers to eventually benefit from the publicity and the recent surge in downloading its trading program. Robinhood has had tremendous success in attracting a new generation of retail customers who think they are keeping it to Wall Street. It announced last year that it had about 13 million accounts.
But trading a storm via so-called margin accounts that allow investors to buy shares with borrowed funds can easily get out of hand. The shortcomings in Robinhood’s approach to risk management have been strongly exposed.
‘They [Robinhood] just hit a piece of two by four in the head, ”explained Larry Tabb, a US expert in market structure. “The volume of Robinhood is very concentrated and if they want to facilitate trading in stocks that rise to overvalued levels, they need more capital.”
The Robinhood fundraiser reflects the demands of cleaning houses. The legal settlement of a stock trade on Wall Street can take up to two days and during that period, volatile stock prices increase the prospect of losses among investors.
It puts Robinhood on the hook to cover shortages among its customers, and as a member of the major U.S. cleaning house, it must also meet the demands for more cash to protect Wall Street from a cascade of failed plumbing industry operations. clogged. Robinhood CEO Vlad Tenev has revealed that a $ 3 billion claim against an extra margin was requested by the House of Representatives last week.
“When people lose money, it creates real issues and Robinhood has to address the risks associated with a less sophisticated investor base,” says Greg Martin, a partner at Liquid Stock, a private market platform that has helped Robinhood owners pursue their interests. sell. “I use the app and like the company, but they need to learn from it and be smart about it.”
The hunt for hot stocks using borrowed money takes place elsewhere, such as Interactive Brokers and Charles Schwab, among others online brokers. But these platforms also have a multitude of clients who buy and sell a variety of exchange traded funds, mutual funds and individual bonds that usually trade at reasonable volatility while generating commissions and fees from asset managers.
In contrast, Robinhood does not earn commissions from its customers. Instead, most of its revenue comes from selling client orders to Wall Street market makers such as Citadel and Virtu, a process known as order flow payment. Market makers obtain information from the streams and earn from it.
As long as the retail day trading boom continues, Robinhood will flourish. But it will likely face the further struggle to pay more securities to the clearing houses to cover customer trade when hot shares rise. This will be accompanied by the increasing political and regulatory scrutiny of Robinhood and the long controversial issue of payment for order flow.
Robinhood may also need to adapt to a natural elimination of the herd for day trading. The recent increase in retail activity will cause many users of the app to discover that it is very difficult to be consistently successful with trading, but only ask for hedge funds and other active investment managers.
Even among those who are happy with the prosperity of short-term trading, some are likely to start moving to an investment position based on growing returns with less volatility while maintaining capital. This opens the door for other brokers and asset managers to earn at Robinhood’s expense. Among them, you will find a real groundbreaker to ‘hold on to Wall Street’.
The honors for opening stock markets for the average small investor and cost savings go to visionary Jack Bogle, who set up the first index investment trust in 1976, a year after founding investor Vanguard. Today, Vanguard manages more than $ 7 tons of assets for investors.
Fiduciaries like Vanguard focus on helping investors accumulate wealth over time through low-cost funds that track markets like the S&P 500. According to Standard & Poor’s, these products have beaten a significant number of more expensive, actively managed funds over the past decade.
“Investors who performed best in the long run are those who performed less and spent less,” said Ben Johnson, director of passive strategy research at Morningstar.