Why is Robinhood taking so much market share in the brokerage industry? Should Robinhood customers be taken seriously? Are they impacting stock prices? These were some of the topics covered in a video discussion between Darren Rockman of Goldrock Capital and Seeking Alpha founder David Jackson. Key points from the discussion:
Robinhood has brought hundreds of thousands of younger investors into the market. That’s a good thing, as owning stocks is the best way to build wealth in the long term.
Robinhood’s innovations were good for investors. It focused on mobile, eliminated trading commissions, and made the UX (user interface) cleaner and more enjoyable to use. These changes are already being adopted by other brokerages and investing tools. Commission free trading is now ubiquitous, and other brokerages are now investing more in their mobile apps.
Robinhood isn’t the only brokerage attracting large numbers of new customers. In Q2, for example, E*Trade added almost 10x the number of new accounts it added a year earlier. The elimination of trading commissions by E*Trade (NASDAQ:ETFC), Schwab (NYSE:SCHW), Ameritrade (NASDAQ:AMTD), Interactive Brokers (NASDAQ:IBKR) and others has probably driven much of this increase. Also, there’s anecdotal evidence that people unable to work due to COVID-19 have turned to trading stocks.
Professional investors shouldn’t look down on Robinhood customers. Professional investors may seem to be more sophisticated, but many of them have got the market wrong because they bought value stocks. In contrast, many individual investors bought growth and technology stocks, which have driven the market. Robinhood customers, who are generally younger, often have a better grasp of technology than older investors.
Does Robinhood encourage younger, inexperienced investors to trade excessively? The concern is valid, and may be intrinsic to Robinhood’s business model. Robinhood makes money from selling order flow for trades, and makes most money from options trades. So it is incentivized to get its customers to trade a lot, and in particular to trade options. This explains why Robinhood investors trade far more than Schwab or Fidelity investors, and trade options far more. However, individual investors succeed most when holding stocks for the long term. The data shows that they underperform the market when they try to time the market or become short term traders, for example by trading options. Because Robinhood makes more money the more its customers trade stocks and options, its incentives are not aligned with its customers. As a result, Robinhood customers may end up overtrading, to their own detriment.
Three changes are happening in the equity research industry. First, for professional investors, trading commissions and payments for research have been unbundled. That’s put downward price pressure on equity research, making it unprofitable for many investment banks. As a result, Wall Street research coverage of stocks is shrinking, with many stocks losing Wall Street research coverage altogether. Discussion of those stocks has moved to Seeking Alpha, which is now widely used by professional investors.
The second change in the research market is that products for individual investors have better user interfaces than products for professional investors. Robinhood’s focus on mobile is a good example of that; another example is Seeking Alpha’s mobile apps, which provide research, news, transcripts, investor presentations, data and ratings for mobile users.
The third change is that products for individual investors now include data and tools which were previously only available to professional investors. For example, Seeking Alpha acquired CressCap, whose quant ratings were sold to professional investors for $5,000 per seat, and its product to Seeking Alpha Premium which is used by tens of thousands of individual investors and costs only $239 per year.
The discussion covers other topics as well, such as whether Robinhood customers are impacting stock prices, particularly in tech. See the video on YouTube.
