What’s all the fuss about ‘Robinhood’ ?

1 month ago - 5 Min. Read
Legendary Outlaw Robin Hood

We’re not talking about the legendary Sherwood Forest Outlaw!

In the light of the recent controversy over GameStop shares, we take a look at the growing trend for casual, amateur investing and how the Robinhood app has enabled this.

Robinhood

Robinhood is a free-trading app that lets any investor trade stocks, options, exchange-traded funds, and cryptocurrency without paying commissions or fees. Robinhood is paid by “market makers” who are typically large investment firms/financial institutions that create liquidity in the market e.g., Citadel.  These market-makers quote both a buy and a selling price and hope to make a profit from the difference between the two, known as the spread.

As Robinhood explains, “When you buy or sell a stock, Robinhood sends your orders to market makers that execute your trades. Market makers send a record of the trade to Robinhood Securities, which works with a clearinghouse to record the trade. It takes two days for the clearinghouse to transfer the stock to the buyer and funds to the seller. This is known as “clearance and settlement.”

This way of ensuring that everyone gets what they agreed to when the trade executed is referred to in the industry as the trade date plus two days to settle (T+2).

What Happened With GameStop?

Recently, Robinhood prevented users from buying shares in GameStop (GameStop Corp., an American video games retailer) and some other companies (Nokia and AMC) after a big price surge upwards for (what had previously struggling) GameStop. It has been reported that amateur investors following the Wall Street Bets forum on Reddit started putting lots of money into buying GameStop’s stock in order to push up the price. This, in turn, would have made it difficult for any of the big hedge fund investors who may have been relying on “short selling”/”shorting”.  This practice, which is essentially betting on the value of a company’s stock value to fall sharply involves hedge funds borrowing shares from investors for a fee and waiting until their value falls before buying them back (for a lesser amount) to make a profit.

The buying of shares by the Reddit forum investors, therefore, appears to have put pressure on the big hedge funds to try and buy back the shares they had borrowed quickly to stop any bigger losses (known as ‘covering’). Unfortunately, this buying back would have helped to keep inflating the value.

Controversy

Robinhood suddenly intervened by preventing users from buying shares in GameStop.  This caused controversy and anger and there were accusations that when it looks as though small, amateur investors look like making some money and hurting the established big hedge funds, their opportunity is stopped. The point was also made by some people that those on Wall Street may only appear to care about the rules when they’re the ones getting hurt.

Government Too

President Biden’s Press secretary Psaki had already said that the new administration’s team had been monitoring the situation and Massachusetts state regulator William Galvin asked the New York Stock Exchange to suspend GameStop for 30 days to allow a cooling-off period, saying that it looked more like gambling than investing.

Legal Action

Afters investors were stopped from buying GameStop shares, a legal action was then filed (last week) which claimed that Robinhood was acting purposely to rig the market in favour of the big financial institutions (who are not Robinhood’s customers) and to retail investors of possible financial gains.

Other Accusations

There were also accusations by commentators on behalf of some of the big financial institutions that the huge amount of trading in GameStop shares by individual investors had been used as a way for people to get their own back on them and deliberately try to demonstrate that they have the power to hurt them.

Also, there were accusations on some social media accounts that billionaire financier Ken Griffin had put pressure on Robinhood to cease GameStop trading in order to benefit Citadel Securities (his company) which acts as a market maker for Robinhood.

Robinhood Says

Robinhood denied that it did anything to deliberately favour the big financial institutions and deprive its customers.  In a blog post it explained that as a Clearing brokerage, Robinhood Securities is a member of clearinghouses which have membership rules, approved by the SEC, that govern the activity of their members. This means that, if a firm’s customers have more buy than sell orders, and the securities they’re buying are more volatile, this can trigger problems and charges.  In the case of Robinhood, the amount required by clearinghouses to cover the settlement period of some securities rose ten-fold, causing the rules to kick-in and this triggered the placing of “temporary buying restrictions” on a “small number of securities”.

Robinhood was keen to point out in its blog post that, “It was not because we wanted to stop people from buying these stocks. We did this because the required amount we had to deposit with the clearinghouse was so large—with individual volatile securities accounting for hundreds of millions of dollars in deposit requirements—that we had to take steps to limit buying in those volatile securities to ensure we could comfortably meet our requirements”.

Robinhood says its goal is still “to enable purchasing for all securities on our platform”.

Popular During Lockdown

Amateur investing, such as that on Robinhood, has become more popular during the lockdown as people have sought ways to learn new things, perhaps make some money during difficult times, and find an extra income-stream going forward.

Criticism

Robinhood has also been the subject of some criticism in that it could be perceived as making investment seem like a “game for dabblers”, could be very risky for investors and could create disruptive bubbles in some stock.

Silver

In the wake of the GameStop episode and following this kind of criticism, it appears that investors have already started targeting silver trading with the silver price hitting 8-year high.

Some analysts have said, however, that it would not be as easy for retail investors to have a massive impact the silver price, because there are not many shorts in this market and there is a large off-exchange market for silver where banks trade on behalf of clients.

Looking Ahead

The move to silver shows that amateur investing looks set to continue and it is likely that there may be more surprises to come via many investors using Robinhood after they have seen that they can have a real effect on markets and on the big players in some of those markets.