#TradingSpaces: Has Robinhood Lost its Luster?

In this week's #TradingSpaces I opine on one of the best known - perhaps, infamous - online trading platforms. Robinhood has attracted millions of new investors, but suffered a major hiccup during the recent GameStop trading war.

Names and personal information are excluded to protect privacy. NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Q: Is now a good time to invest with Robinhood after the Gamestop saga?

A: Robinhood offers free trading to 13 million small investors. It makes its money by routing orders to market makers including Citadel Securities. Critics contend that its business model has an inherent conflict because Robinhood generates revenue by selling customers' stock orders to larger trading firms.

Robinhood’s CEO, Tenev, contends that the practice of routing orders allows companies like Robinhood to offer commission-free trading to small investors (the company receives more than 50% of its income from such transactions – its biggest source of income). "We simply play by the rules. Payment for order flow has been approved by the SEC. It is customary practice. I do believe it's been an important force for innovation in the industry."

GameStop Kerfuffle

After suffering six or so years of stock price declines as sales of video games increasingly moved online, GameStop attracted the attention of the Wall Street buzzards, more commonly know as the short sellers - investors who borrow shares and immediately sell them anticipating a price decline. Whether or not a decline happens, they have a legal obligation to buy back shares (regardless of price) to replace those borrowed and hopefully pocket a positive price difference. Fact is, GameStop became one of the most “shorted” stocks on Wall Street. Then came the 2020 rebound.

The stock rose sharply, particularly in early January 2021, after a co-founder of Chewy joined GameStop’s board hoping to transform the company by focusing more on digital sales and less on its struggling brick-and-mortar outlets. Though alarmed by the sudden price increase, short sellers remained pessimistic that GameStop's stock could retain its stock price gains. After all, they say, it’s just a place to buy a video game.

But then, a blood-letting broke out involving countless small investors, many of whom were neophyte traders making a bold… and surprisingly successful… stand against a cohort of savvy hedge-funders. Shares of GameStop spiked dramatically for fundamentally questionable reasons. Occupancy of the high ground offered increasing validation to this cohort of small investors, encouraging others via Reddit… many for the first time… to buy the stock through brokers on free trading apps, such as Robinhood.

Faced with what Robinhood insisted was a need to raise more capital to meet clearinghouse requirements, the company halted trading in GameStop and other stocks. ‍‍This sparked a backlash among customers, questions from lawmakers and a number of lawsuits. Tenev denies that the company was pressured by hedge funds to halt trading in GameStop… that the trading halt was due to his company's need to raise more capital per clearinghouse requirements. Robinhood raised $3.4 billion from investors over four days in order to meet increased capital requirements.

Take It or Leave It?

I personally see no reason to stop investing with Robinhood because of this widely publicized incident, but I’m inclined to parrot Berkshire Hathaway’s vice chairman, Charlie Munger who, when asked about Robinhood’s influence on young traders, said, “I hate this luring of people into engaging in speculative orgies. Robinhood may call it investing, but that’s all bulls—t.”

Perhaps Charlie and I think the same, but for different reasons. I’m a buy-and-hold guy, so I naturally think of day trading as a bulls—t approach to investing.

In other words, I would use Robinhood for its free trading features, but practice PDQ principles. Buy quality, diversify your holdings and exercise patience.