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“How as a 20-year old with no income able assigned almost a million dollars’ worth of leverage?”, this was the simple question asked in the note written by Alexander E. Kearns, a 20-year old student at the University of Nebraska, home from college living with his parents. Earlier that day, on June 12, 2020, Kearns took his own life. Kearns apparently took this tragic step after looking at his Robinhood account, which appeared to have $16,000 but also showed a negative cash balance of $730,165. His family believes that when he saw the $730,000 number as a negative cash balance, he thought he had blown up his life, prompting him to take the step.
Robinhood is a fast-growing trading app, which allows users to buy and sell U.S. stocks, ETFs, options, and cryptocurrencies without commission. The company has raised $1.2B dollars in funding and analysts estimate that its current revenue stands at $100.6mm. The pandemic has led to a surge in the number of uses on Robinhood, the company added a record 3 million new accounts on its platform in the first quarter of 2020. Financial market commentators have attributed the recent stock rally in the US (especially in companies facing bankruptcy, such as Hertz) to the Boredom Market Hypothesis, the idea that an important force driving markets is the demand of retail investors for entertainment when traditional avenues of entertainment are shut down. The basic theory is that ordinary people will do more trading (1) if trading is entertaining and (2) if other things are less entertaining: The more bored they are, the more they will trade stocks.
But Kearns' demise is a cautionary tale of the serious financial risks associated with trading. Making money trading stocks is difficult, even for the most seasoned traders. History is replete with examples of traders’ lifetime gains being wiped out over the course of a single market event. For retail investors with limited financial acumen, access to information and advice, the risks are compounded. Allowing retail traders to execute complex options strategies, without understanding the inherent financial risks is a recipe for disaster.
In a sense, financial services are unique, arming users with access to more products (delivering greater value) may lead to the promotion of detrimental activities. Providing retail investors, the ability to trade in the financial markets without user education or oversight may have disastrous consequences, as the Kearns incident highlighted. Though the app claims to teach users to ‘learn how to invest’ through its free trades, there is real money at stake when users are not properly educated and are unclear about how to allocate their hard-earned savings. This coupled with concerning news in March, where users reported three outages in two weeks, highlights the dangers of operating in the financial services industry.
It is unclear how the company is dealing with these challenges. Robinhood has claimed that they are taking steps to minimize the potential of such incidents through educational offerings, notifications, messages, and emails so that traders are aware of the mechanics of their trades. On the other hand, the company is experimenting with social trading with the ‘Profiles’ feature, essentially allowing users to crowdsource investment advice. Social validation may bring more users to the app, and enable users on the fence to pull the trigger, but crowdsourced advice, may not be the best advice for its users.
Robinhood is democratizing access to financial markets and bringing in large swathes of users. But as Ben Edwards, a business and securities law professor at the University of Nevada, Las Vegas, suggested to the Wall Street Journal back in January, “Free apps and this bull market are bringing the ability to make foolish decisions to an ever-broader swath of people.”
About the author: The post is written by our EZPP partner Aman Jain with relevant edits from our editorial team. Aman is a graduate from IIM Kozhikode and has a PPO from the Boston Consulting Group.