In the spring of 2020, Alex Kearns, a 20-year-old University of Nebraska student who had traded on Robinhood for two years, began diving deeper into investing, taking on a new financial challenge: option trading. However, it wasn’t until the summer that his lack of advanced securities experience caught up with him. Making a spread trade on a Russell 2000 Stock Index, he woke up the next day to a negative balance of $730,000, greater than the value of the assets he had held and deposited. With Robinhood’s interface not clarifying the negative balance would be offset by the rest of the puts he owned and the customer service automatic inquiry not clarifying the situation, Kearns, in a state of panic, decided to escape his guilt by committing suicide.
This is one of the many stories in which Robinhood has proven to be a tool for the rise and demise of retail investors. The lack of clarity coupled with the ease at which inexperienced students and investors can handle advanced securities such as option spreads brings up an important question: does the platform, aimed to democratize finance, actually make it too easy for inexperienced investors to lose money — and even their lives — in the market? Although the movement to bridge the wealth inequality gap is highly progressive, Robinhood not only disregards the barriers and acknowledgments of risk other firms utilize but also helps promote high-frequency trading, forgoing fundamental investing in accruing long-term wealth.
Robinhood, the zero-commission industry disrupting trading platform, was founded in 2013 by Vlad Tenev and Baiju Bhatt, two Stanford students who crossed pathways in 2005. After years of evolving their friendship through several ventures, including creating a high-frequency trading platform, the two individuals were moved by the Occupy Wall Street movement — a movement against economic inequality and monetary power in politics — to start a trading platform more accessible to the public. Although facing long-standing competitors, they appealed to the census through two main ideas: no trading fees, compared to other companies at $5-10 per trade, and no account minimum. The low entry barriers enticed younger individuals, many of whom had never traded in the past.
When it concerns revenue, Robinhood’s primary source is “payment for order flow,” a form of micro compensation that a brokerage firm can receive for directing orders to a particular exchange or market maker. This means the more customers place orders, the more money the platform makes. Still, there’s much to thank the company for, including bringing down commissions on large investment firms to zero and bringing a new generation to the world of investing.
The Gambling Controversy
Since the move towards democratizing finance began, four main features of the app have been the source of controversies and accusations of gambling, whether derived from Robinhood’s user interface or certain features they’ve added to their platform.
- Free Stock: From the beginning, new Robinhood members could obtain a free share of stock, valued up to $200, serving as another reason individuals would join the platform. How could anyone turn down anything free, especially a share of stock? However, the method by which the app gamifies the stock reveal — scratching off a lottery ticket — imitates the behavioral reaction of gambling and the lottery.
- User Interface: While Robinhood is straightforward in terms of usage, the platform lowers the barriers to trading to allow any individual, such as Alex Kearns and the highly inexperienced, to put their money into the market — even advanced securities. Skipping several steps when trading while coloring the entire UI as green — the color of luck and money also found in Las Vegas — they make their app much less intimidating than others and, subconsciously, encourage more frequent trading.
- Confetti: Until a few years ago, Robinhood users would see confetti on their screen due to placing their first trade. While it may seem harmless, Gary Gensler, the head of the SEC, and others called out the feature for serving as a behavioral prompt, causing individuals to more frequently trade, which would, in turn, heighten Robinhood’s revenue. Although Vlad denied any connection between these two factors, the company has since removed the feature.
- Options Agreement: While other brokers often require traders who seek to engage in options to fill out and sign another form called the Options Agreement, Robinhood breaks down these barriers of entry by a few multiple choice questions. Additionally, although providing some websites to help with using these securities, they do not actively warn investors, especially those inexperienced, about the risks.
This feeling of gambling that Robinhood emulates, while not claiming to, is one of the critical reasons inexperienced investors, who haven’t been weathered by the difficulties of the market in the past and lack fundamental experience, would end up losing money in the market at a much faster pace than others. Although gambling is not directly correlated to investing, the behaviors it promotes, whether through the confetti, the free stock, or the color of the UI, contribute to investors finding the platform more game-like and thus “investing” at a much more rapid rate.
Some of the issues don’t lie in the investors; Robinhood, a relatively newer platform, also has technical issues that cause inexperienced and experienced investors to lose money.
Although there are several examples, one notable event was in March of 2020. Following the CDC announcement of the COVID pandemic combined with prevailing supply issues, the stock market began taking a hit, causing investors to panic. Unfortunately, due to the amount of traffic on the site, Robinhood’s infrastructure completely collapsed, causing these investors’ funds to be locked and inaccessible: once on the 2nd and the other on the 9th.
One individual, Richard Dobatse, was a prime example of the losses suffered by inexperienced investors and the faulty software. Having been a passive investor to accrue retirement and generational wealth, it wasn’t until he joined Robinhood that he became more active. He began taking out home equity loans and credit card advances totaling about $75,000 to speculate and trade stocks and options. While reaching an account value of nearly $1,000,000 at the beginning of 2020, the March Robinhood outages and the inexperience of recession on such volatile securities caused his portfolio to plunge. In June 2020, his portfolio’s value was a mere $6,000, less than the value of the assets he had deposited into his account.
While there remain several others — from a glitch in 2019 that enabled infinite borrowing to supersize existing gains and losses to the Dogecoin run in 2021 — it’s essential to take away the effect these events have on investors, especially those inexperienced.
With Robinhood’s features imitating gambling and a game-like platform through several features, investors are provided with the illusion that beating the market consistently is highly probable and would give a greater payout than fundamental investing. While payouts have been massive with certain frenzies last year, numerous scientific studies conducted over several years prove frequent trading leads to worse returns, with day trading providing the most disastrous results. Even brokers with significant funds have been unable to beat the market consistently, thus making day and short-term trading another form of short-term trading Robinhood has promoted and cost investors money.
Even before the COVID surge in trading, Robinhood users traded 9x as many shares as E-Trade customers and 40x as many as Charles Schwab. The user interface and the small features — confetti, the low barriers to trade, and the ability to take on advanced securities quickly — promote this behavior; in fact, it’s difficult to hide the massive conflict of interest: Robinhood’s revenue versus their customers. With their primary source of income coming from payment for order flow, Robinhood encourages more active trading, while their users continue to live in the belief they can beat the market with their frequent trading methods.
Attention Induced Trading
According to The New York Times’ data, the average age of Robinhood’s users is 31 years old, while nearly half of these users have never had experience in the market before. Moreover, compared to any other platform, Robinhood is known to have the most first-time investors, meaning these individuals, lacking knowledge of research and fundamentals, engage in whatever stock grabs their attention: whether from news headlines or blog posts.
In herds, these investors jump into the mosh pit during these surging prices, while short-sellers, aware of the herding behavior, profit from the typical behavior. Data from the study performed by professors show that popular stocks — those that grab first-time investor attention — tend to fall 5% in the next month, with those extremely popular falling about 9%. These stocks chosen by inexperienced investors are not based on fundamentals but instead on their prevalence in the media and current stock value, creating a feedback loop and the foundation of a price bubble.
Now, Robinhood also remains accountable due to its UI. Instead of highlighting many stock level indicators that are otherwise shown through other brokers, they grab the eye of the inexperienced investors with phrases including “Top Movers” or stock lists including “100 Most Popular Stocks,” exacerbating this issue.
Is Robinhood Responsible for New Investors’ Losses?
It’s difficult to say yes or no to such a loaded question about whether or not Robinhood is the reason for these inexperienced investors to lose so much money. While they are almost directly responsible for unfortunate events such as the death of Alex Kearns due to their unclear user interface and lowering the barriers to allow inexperienced investors to handle advanced securities, the platform is also responsible for introducing a new generation to the world of investing and democratizing finance. Their mission has encouraged investors to get into the market, yet with social media influencers on TikTok and Instagram promoting short-term and day trading over long-term and fundamental trading, Robinhood has merely been a tool towards making investors lose money in the market.