Moving fast and breaking things is a hallmark of disruptive companies and revered by investors during today’s bull market.
For Robinhood, Silicon Valley’s online trading platform with its super-accessible and seductive app, the breach collided head-on with the guardrails that protect the financial system.
In the wake of increasing customer trading volumes around GameStop and other major stocks, Robinhood was compelled to raise $ 3.4 billion in two separate infusions of capital in a matter of days.
Supporters, led by Ribbit Capital, certainly hope that the broker will benefit from advertising and the recent increase in downloads of its trading app. Robinhood has achieved tremendous success in attracting a new generation of retail customers, who think they are “clinging to Wall Street”. She disclosed last year that she had about 13 million accounts.
But trading like a storm through 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 were clearly revealed.
“They [Robinhood] it was just hit in the head by a two-by-four piece, ”explained Larry Tabb, a specialist in US market structure. “Robinhood’s volume is very concentrated and if they want to facilitate trading in shares that rise to overvalued levels, they need more capital.”
Robinhood’s fundraising reflects the demands of the clearing houses. The legal settlement of a Wall Street stock trade can take up to two days, and during that window, volatile stock prices increase the prospect of loss among investors.
This puts Robinhood on the hook to cover any shortcomings among his clients, and as a member of the U.S.’s leading clearinghouse, he must also meet demands for more money to protect Wall Street from a cascade of failed negotiations that obstruct the financial pipeline. Vlad Tenev, chief executive of Robinhood, revealed that a demand for $ 3 billion in extra margin was sought by his clearinghouse at the height of the trade storm last week.
“When people lose money, it creates real problems and Robinhood will have to deal with the risks associated with a less sophisticated investor base,” said Greg Martin, a partner at Liquid Stock, a private market platform that helped Robinhood owners to sell their stakes. “I use the app and I like the company, but they need to learn from it and be smart about it.”
The search for hot stocks using borrowed money occurs elsewhere, such as Interactive Brokers and Charles Schwab, among other online brokers. But these platforms also have many customers who buy and sell a variety of exchange-traded funds, mutual funds and individual securities that are generally traded at reasonable levels of volatility, while generating commissions and fees from asset managers.
In contrast, Robinhood does not earn commissions from his clients. Instead, the bulk of its revenue comes from selling customer orders to Wall Street market makers like Citadel and Virtu, a process known as the pay-per-order flow. Market makers obtain information from these flows and profit from it.
As long as the retail day-trading boom continues, Robinhood will thrive. But it is likely to face new crises of having to pay more guarantees to clearing houses to cover client trades whenever stocks are up. This will be accompanied by greater political and regulatory scrutiny about Robinhood and the payment industry’s long and controversial issue of order flow.
Robinhood may also have to adapt to a natural slaughter of the day-trading flock. The recent increase in retail activity will make many users of the app discover that having consistent success in trading is very difficult – just ask hedge funds and other active investment managers.
Even among those fortunate enough to thrive on the cut and momentum of short-term trade, some are likely to begin shifting to an investment stance based on increasing returns with less volatility, while preserving capital. This opens the door for other brokers and asset managers to profit at Robinhood’s expense. Among them, you will find a true pioneer in “cheating on Wall Street”.
Praise for opening stock markets to the average retail investor and cutting costs goes to visionary Jack Bogle, who launched the first index investment fund in 1976, a year after founding investor-owned Vanguard. Today, Vanguard manages more than $ 7 trillion in assets for investors.
Trusts like Vanguard focus on helping investors accumulate wealth over time through low-cost funds that track markets like the S&P 500. Over the past decade, these products have outperformed a substantial number of more expensive and actively managed funds, according to Standard & Poor’s.
“Investors who have performed best in the long run are those who have done less and spent less,” said Ben Johnson, director of passive strategy research at Morningstar.