Buzz
As WSJ columnist James Mackintosh recently observed, the stocks that performed the best last year were priced under $1, which is unusual since a stock's price doesn't really reveal much about the company itself. This trend aligns with the rise of individual investors using trading platforms like Robinhood, known for its user-friendly interface. But is it too simple? Are amateur traders even aware of the risks they are taking?
The rise of gamified stock trading
While the advantages of democratized trading shouldn't be dismissed outright, it exists alongside a cautionary reality: some individuals should avoid trading apps entirely. According to a recent feature in the New York Times, studies show that the more often small investors trade, the worse their returns tend to be.
Like other retail trading apps, Robinhood allows users to buy and sell stocks, alongside more complex trades. However, it stands out for fostering aggressive trading, which is amplified by the app’s gamified design. As noted by the Times, this combination has led to a highly speculative environment among users.
Robinhood users are known for trading high-risk products more rapidly than users of other retail brokers. In the first quarter of 2020, they traded nine times more shares than E-Trade users and 40 times more than Schwab customers, based on the average account value.
Moreover, Robinhood traders engaged in 88 times more risky options transactions than Schwab customers, proportionate to account size, according to Alphacution's research.
New users receive a free stock as a sign-up bonus, but only after scratching off images that resemble a lottery ticket. Other features, such as falling confetti and emoji-laden notifications, create a game-like experience.
Initially, Robinhood only offered stock trading, but soon expanded to include options trading and margin loans, which can amplify both gains and losses. To access these tools, users simply need to answer a few multiple-choice questions.
Robinhood’s business model is built around incentivizing frequent trading. While it doesn't charge commissions, it profits when users make more trades through a practice called "payment for order flow." This practice is also used by firms like E-Trade and Schwab, but Robinhood generates more revenue from it than they do.
How to Use Robinhood Safely
The fundamental rule of trading is to never invest more than you can afford to lose. If you're not an experienced trader who understands how to evaluate a company’s financials, market position, and management, it's best to view trading as a form of gambling and take similar precautions. For responsible trading, check out Nerdwallet’s guide on best practices for day trading to avoid losing big in the long run.
