Robinhood democratises investment for all but at what cost? Regulation is necessary

My investment manager chums have been agog these past few weeks at the exploits of the Robinhoods. Note the spelling. I don’t mean the legendary figure who roamed the woods of Nottinghamshire stealing from the rich to give to the poor. I refer to commission-free share trading. There are several apps that offer such a service but the leader is Robinhood, with more than 13 million users.

So popular has the fintech platform become that these retail or private investors piling into stocks are now known as “Robinhoods”. They can be defined still further: the median age of this new breed of amateur playing the stock market is 31; and the share prices of the companies they’re targeting tend to have crashed. In short, they’re jocks, more used to having a flutter on live sport or down at the casino. Stuck at home, bored by lockdown, itching for a buzz, and seeing what they believe to be a chance to have a bet and make a killing, they turn to stocks.

Many of them adopt the same deeply analysed and thought-through techniques (ie, non-existent) as they use to back a horse or a number in roulette. They like the sound of a business, they might recognise it as a famous brand, one that’s been around for a while and does not deserve to be where it is and will surely bounce back. They think they know best, that they’ve spotted something the professional experts have failed to see.

So, wiser heads in the investment community are shaking at stories of private investors seizing on shares that have taken a beating and pushing them upwards. The classic is Hertz, the car rental giant, which has seen its shares climb 250 per cent in the past fortnight – at one stage they were up 680 per cent. The fact that Hertz is in the middle of bankruptcy proceedings and its shares will be decimated by the time the creditors have had their say seems to pass its new investors by.

Then there was FANGDD Network, a little-known Chinese property company that suddenly became a stock market sensation, after its American depositary shares soared 1,250 per cent. The reason? The only one fathomable is its name is similar to the FAANG acronym used to describe tech giants Facebook, Apple, Amazon, Netflix and Google.

Indeed, any company with a short, single name that has a familiar ring is fair game. Better still if it’s issued bad news. In jump the Robinhoods.

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The mission statement of Robinhood is “democratising finance for all”. It’s hard to resist that reasoning. You only have to remind yourself of firms earning fortunes from applying charges in return for doing not much at all, to applaud the ambition.

There is an investment adage, however, that should enjoy equal promotion: “when something is too good to be true it usually is.” And that’s where the trouble starts. Allowing folk free online trading is one thing; but sitting back and watching while the herd instinct, the madness of crowds, takes over is quite another.

The phenomenon sparked by Robinhood and others (some reputable names such as Charles Schwab have also climbed aboard the free-means-freedom bandwagon) is not new. The history of the markets is sprinkled with examples of those who thought they could beat the system, only to come almighty croppers. As billionaire investor Leon Cooperman, someone who has seen it all before, says, the Robinhoods are “just doing stupid things, and in my opinion, this will end in tears”.

There is a feeling, though, echoed by Cooperman, to “let them buy and trade”. It’s their cash, they’re grown-ups after all, so where’s the harm?

That would be a reasonable position to take if they could afford to lose. It’s not unlike the controversy that besets the gambling industry. The bookies do their bit by imploring “when the fun stops, stop”. Sadly, it’s not so simple, not all people can quit, and are able to just walk away, having had some fun. Alas, countless lives have been ruined by addiction to betting.

For many of the Robinhoods, share prices afford a similar thrill. Except the markets are more complex than guessing the roll of a dice or backing a horse. Robinhood does not stop at the mere straight buying and selling of shares. The app can be used to trade options. And options can quickly take the inexperienced into a dangerous sphere, to a whole new level of profit, and loss. Sure enough, tales are starting to emerge of Robinhoods being wiped out, and worse. This was posted on a financial website:

“My cousin-in-law was interested in investing. He opened a Robinhood account. And, he seemed to be enjoying the markets. As many of us do, or have done, he got interested in options. He believed he had ‘no margin’ selected on his account. So, he began buying and selling options. Fast forward to sometime this past week and his account showed him owing $700k+. How does a 20-year-old with no income get access to that kind of leverage/exposure?! The emotional stress from the exposure caused him to take his own life. I don’t feel right sharing this, but I also don’t feel right keeping it from the world.”

There have been examples, too, of the Robinhood app freezing, of not being able to cope with demand when the stock market surges. Technical glitches have left clients unable to move their money at critical moments, and legal actions have ensued. Robinhood is too popular, the numbers are too large, the risks too acute, for the authorities to do nothing. They have to step in, to regulate, to licence and to enforce. I’m all for democracy but in this case, it has its limitations.