If it was hard to trade stocks in the previous years, now it is as easy as downloading an app or sending a tweet, and most importantly, it is free of charge. This new online trading model represented an "innovation shock" in the trading market. Due to the Covid-19 pandemic, almost any part of the world faced a significant period of lockdown, where people locked in their homes, binge-watched Netflix shows, went shopping on Amazon Prime and many of them, with live sports and sport-betting canceled, discovered day trading on their mobile phones. This kind of "frenzy" retail traders started to be called "Robinhood traders", from the revolutionary trading app "Robinhood".
Robinhood was founded in 2013, introducing two disruptive elements in the trading industry: zero commissions and fractional stocks (that allowed people who can't afford the most expensive securities like Amazon or Apple or Tesla, to buy a piece of share). The company received a valuation of 11.7 billion dollars in its most recent venture capital funding round, it has more than 13 million customers, 3 of whom signed up in the first four months of the year. The goal of the company is to become public, offering a broad range of services including individual retirement accounts, mortgage lending, car rental and insurance and even life insurance.
Robinhood has an innovative way to attract new users, using the same logic of viral loops of social media like the possibility of getting a free share of stock in exchange for inviting friends to sign up. This created a strong millennial-age customer base, indeed about 80% of its assets under management come from millennial users and half of new Robinhood customers this year were first-time investors, the company said in May. This model has a huge success in new generations because it introduces a compulsive and dependent logic towards the trading activity by transforming it, through simple and convenient access in the market, in a game, a form of entertainment like sports betting. David Portnoy, founder of the website and podcast empire Barstool Sports said, "Wall Street people don't love this—it's legalized gambling" and "Just like sports betting is entertainment, I think the stock market is entertainment. I don't think there's anything wrong with that". Also, Charles Rotblut, vice president for the American Association of Individual Investors said, "It's like playing poker—as long as you have a little money, you can sit down and start competing".
It is crucial to analyze what are the effects of such strong democratization of the investment activity. Online trading platforms, such as Robinhood, have contributed to creating a crowd of untrained and inexperienced individuals who often approach the market in a non-scientific way, using none of the deterministic approaches or tools that professional investors use to analyze stocks movements and liquidity and solidity of public rated companies. A clear example of that is the case of Hertz Global Holding Inc. where in early June Robinhood traders piled in the company and shares of the bankrupt car rental began to surge. Now, small and retail traders, which made up almost 20-25% of market transactions, seek any opportunity to get rich quickly by exploiting the leverage of the buy signal of a mass of users.
Robinhood was founded in 2013, introducing two disruptive elements in the trading industry: zero commissions and fractional stocks (that allowed people who can't afford the most expensive securities like Amazon or Apple or Tesla, to buy a piece of share). The company received a valuation of 11.7 billion dollars in its most recent venture capital funding round, it has more than 13 million customers, 3 of whom signed up in the first four months of the year. The goal of the company is to become public, offering a broad range of services including individual retirement accounts, mortgage lending, car rental and insurance and even life insurance.
Robinhood has an innovative way to attract new users, using the same logic of viral loops of social media like the possibility of getting a free share of stock in exchange for inviting friends to sign up. This created a strong millennial-age customer base, indeed about 80% of its assets under management come from millennial users and half of new Robinhood customers this year were first-time investors, the company said in May. This model has a huge success in new generations because it introduces a compulsive and dependent logic towards the trading activity by transforming it, through simple and convenient access in the market, in a game, a form of entertainment like sports betting. David Portnoy, founder of the website and podcast empire Barstool Sports said, "Wall Street people don't love this—it's legalized gambling" and "Just like sports betting is entertainment, I think the stock market is entertainment. I don't think there's anything wrong with that". Also, Charles Rotblut, vice president for the American Association of Individual Investors said, "It's like playing poker—as long as you have a little money, you can sit down and start competing".
It is crucial to analyze what are the effects of such strong democratization of the investment activity. Online trading platforms, such as Robinhood, have contributed to creating a crowd of untrained and inexperienced individuals who often approach the market in a non-scientific way, using none of the deterministic approaches or tools that professional investors use to analyze stocks movements and liquidity and solidity of public rated companies. A clear example of that is the case of Hertz Global Holding Inc. where in early June Robinhood traders piled in the company and shares of the bankrupt car rental began to surge. Now, small and retail traders, which made up almost 20-25% of market transactions, seek any opportunity to get rich quickly by exploiting the leverage of the buy signal of a mass of users.
All of this has a strong impact on one of the key elements of all portfolio strategies, as well as trading algorithm strategies: volatility. High-frequency trading algorithms for example use volatility indexes (like the VIX of the S&P 500) to guide their decisions of buying and selling high volumes of securities, as a consequence when the volatility is too high, they start to sell. The combination of a mass of inexperienced investors with a high appetite for risk and these automatized mechanisms lead to an amplification of every event that affects the financial market, such as the Covid-19 crisis.
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Here we can see the sensitivity analysis of the VIX Index for the S&P 500, from which we can perceive how, even after March, the Index stabilized at around twice the value recorded in 2019. This trend is for sure influenced by the overall economic present conditions, but certainly, retail investors represent one of the factors that affect this progress.
The other bullet point of discussion is the quality of investors. In the 1929 crisis, the financial bubble pushed many individuals with no income to buy stocks using leverage and after the crash they lost everything they had. Now this dynamic is even more amplified because everyone can potentially become an investor, thus increasing the number of people exposed and with no or little coverage to negative rebounds, financial crisis and "black swans".
In conclusion, the new trend of online investors can represent a significant threat for every kind of investor category that regularly operates in the market if it's not a controlled and regulated phenomenon and now it's not. History teaches us that a policy of extreme deregulation, such as the Glass Steagall act repeal in 1999 under the Clinton presidency, can have deep negative effects on markets and the overall economy, so financial regulators and public institutions must take action to set solid and precise boundaries before it is too late.
Matteo Girello