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The story of “Robin Hood and his merry men” is a romanticized one, where a group of outlaws or peasants robbed from the rich to give it to the poor. So, when the venture capital backed brokerage advertised no brokerage charges and named it “Robinhood”, it made big headlines.

Their focus was clearly towards capturing the attention of the poor millennials and so they did. They introduced an easy to use smartphone app to trade stocks. It even allows users to buy fractional shares. This is a very attractive feature especially for many youngsters who cannot buy high-priced shares like Tesla, but they can buy a fraction of it. E.g. if Tesla shares are trading at 1000, an investor can purchase 1/10th of a share for the price of $100.

All these additional features with no brokerage charges! So, what is the catch? We will get to that in a minute. The smartphone app became really popular with the millennials when lockdown was mandated. In the first quarter of this year alone, they signed up 3 million new clients. It now has 13 million customers surpassing a very established firm like Charles Schwab which was established in the early 70’s and has 12.3 million customers.

They thrive on something called “surveillance capital”. Remarkably similar to Google and Facebook’s business model. They also offer free services. Are the services really free? Think about it. They collect our data, package it in different ways and use it for advertising – collecting top dollars.

The key point in this is, if the product or service is free, it means the consumer is the product.

Robinhood does something similar. If you study their legal disclosure, the company is routing most of its customers’ orders through hedge funds for execution.

One of the market makers that Robinhood uses is Citadel Securities - the world’s biggest fixed-income market maker and a major player in retail equities market-making. They have very sophisticated automated trade execution capabilities. Robinhood routes close to 70% of their orders through Citadel Securities. So how does Citadel Securities make money? They front-run them. They buy the stock first, and they turn around and sell it to the unsuspecting Robinhood customers at a higher price.  All this happens at lightning speed. It is a minuscule profit that they make but with the high volume that they receive it really adds up. Just like the “house” in a casino, Robinhood and Citadel Securities doesn’t lose any money. More the volume, the merrier they are.

Editor's Note: Despite allegations that Robinhood and Citadel Securities engage in front-runnings order practices, it has not been proven that Citadel Securities conducts these type of orders, an activity prohibited by the SEC.

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Is this legal? Well, they have found ways to stay on the right side of law. No doubt, it is a nearly deceptive practice.

50% of Robinhood account holders have no experience with trading at all. The average age group is 30 and the average account size is $2000, whereas at E-trade it is close to 70,000 dollars and at Morgan Stanley, it is close to a million dollars. The customers at Robinhood have no idea what is happening.

So surely, they are not getting the best price on their trades. These fat cats are robbing from the poor to benefit themselves. Robinhood is pinching the poor to fatten the rich!

Robinhood makes money from their market makers as they pay Robinhood for the luxury of executing their orders. It is information for the market makers immediately and for future trades to come.

Last year, Robinhood was fined 1.25 million dollars by FINRA for allowing their brokers to front-run their orders. But does that really matter for a company that is valued at 8 billion dollars. Citadel Securities was fined 22 million dollars by the SEC in 2017 for misleading their clients.

Robinhood was intended to create a level playing field with the one-percenters to benefit the less rich who couldn’t access the markets. Is that what is being achieved?

So, how can investors protect themselves from the cunning ways of Robinhood? Firstly, do not put market orders. Always put limit orders. If the market comes to your level your trade is executed. Secondly, do not put your stop-loss orders in the market. When the market maker can see an aggregate of orders at a particular level, they will invariably look to hunt you down.

So be smart in using this app. That way at least you will limit yourself from feeding the rich.

NOT investment advice - for informational purposes only. Breezy Briefings’ publications contain information, opinions and data that Breezy Briefings considers being accurate or based on the date of their creation, based on the economic, commercial financial or market context at the time. It does not constitute either a personalized investment recommendation or a general investment recommendation. The information provided comes from the best sources, however, Breezy Briefings cannot be held responsible for any errors or omissions that may emerge. Readers and recipients are requested to consult with a professional legal, tax, accounting, investment advisors before making any material decisions. This publication does not constitute an offer to sell or investment advice and does not engage the responsibility of Breezy Briefings.

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