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Business Unusual

A business bedtime story about Robinhood

7 October 2020 7:15 PM

New investment platforms are making it easy and cheap to invest, what could go wrong?

There are many aspects to this subject and I am only mentioning the basic principles rather than the specific benefits or drawbacks of the platforms and companies mentioned.

Consider this as a business bedtime story instead. It has heroes and villains, dramatic events and an ending that while not a fairy tale ending might not be a bad one either.

Once upon a time

Our story begins with an even older story of Robin Hood, a mythical (or real) character that was said to live in Sherwood Forest with his band of merry men. They would steal to support themselves. But after hearing about how harsh the Sheriff of Nottingham was treating the poor people that lived in the area they focused their robberies on only the rich and would give some of their loot to the poor that needed it. Hated by the Sheriff and the wealthy, they did not see themselves as thieves but rather as agents for redistributing wealth that was otherwise only available to the rich.

Next, we move to a couple of men a little over a century ago that noticed that the growing interest in being able to buy stocks in companies in New York favoured those with specific information about how each of the companies was doing. They saw information as being important to allow everyone to benefit and set about creating a list that would indicate how specific stocks and the market, in general, were performing. That led to the founding of the Dow Jones Industrial Index and the trend to have stock exchanges all around the world report on the performance of companies in a way that gives everyone a fair chance to make a profit for a good investment.

Read next: How the Dow Jones Industrial Index tracks the state of the US stock market

A century later and those two stories combine when two software engineers working on sophisticated software to allow large brokerages to process huge volumes of trades quickly and cheaply decide to start their own company. For most investors using established brokerages, they would need to pay a fee for each trade. The trade itself these days may cost almost nothing, but the brokerage would charge as much as $10 per trade. When placing big orders or if you have large portfolios, those fees are not an issue, but for small investors, they were a big cost.

In an attempt to give access to those that did not have enough to open the expensive accounts and pay the fees they founded Robinhood in 2013.

A much younger investor could now buy shares via a simple app with no minimum balance and pay no fees for unlimited trades.

Like the daring Robin Hood of yore, the new app gave those that would otherwise not be able to access the world best-known wealth creation tool a way to do so. Previously it was effectively reserved for those who already had money to make even more.

This might have been the end of our story with Robinhood growing to have millions of users, make billions of dollars of trades and be valued before listing at an impressive $8 billion.

But wait there's more

Bedtime stories are not much fun without a bit of drama and this story has it in spades.

When the pandemic struck, millions in the US lost jobs so they needed to find a new way to earn some money. Millions more that were used to betting on sports or going to casinos no longer could but one market was still operating - the stock exchange and while you might have thought the pandemic would have sent it into a deep depression, the opposite appeared to happen after an initial crash the stocks rose and kept rising.

For many, this was too good an opportunity to miss but many did not know what to buy and because most did not have lots of money the temptation to buy options looked even more attractive than just buying shares.

There were two places that young investors went looking for guidance on what to do. Reddit and YouTube.

Reddit, in particular, had a bizarre thread called WallStreetBets that like their name suggests was not for the faint-hearted. Popular posts would talk about taking big risky positions with huge celebrations when they were successful and sometimes as big celebrations when they failed.

One user had spent $7000 on options just before the pandemic smashed the United States and "bet" that the market would fall. It did and it earned him $100 000 in a short time. He shorted the S&P again and increased his return to $600 000. Not bad for a young person in just a few months in the middle of a pandemic. After taking $100 000 as profit, he reinvested on the S&P falling once more, but rather than go down, it went up. In just a few weeks he had lost everything except the $100 000.

The thing that caused the stock exchange to rise was the huge stimulus by the US government not only to companies but to most Americans and what many chose to do with that cash is buy stocks.

Buying stocks while they are rising probably feels great because as long as people are willing to buy, the demand will cause the price to rise, but when it stops it can turn quickly and you are stuck with an overpriced share.

YouTube is the second most popular search engine so when you are looking to find out how things work, odds are you will find a video about it there. The interest in beginner investing has resulted in hundreds of channels and thousands of videos promising the truth about investing, many are very good but some are simply looking to spread the same crazy theories and stories as wallstreetbets.

The sentiments by such a large group of people to take highly speculative positions actually can have an impact on the market. Some institutional investors and high volume automatic trading platforms follow the posts on Reddit to get ahead of what might be a surge in buying or selling certain stocks.

But did they live happily ever after

You might think our heroic young investor is battling for their stake of the investment pie, but with very shady advice on forums that call their investments bets to investment platforms that effectively pass your trades to other traders for their benefit things don’t look very rosy. When you are compelled to take very risky positions because you lack the resources or time to make safe long term investments then despite the possibility that you may be able to slay a dragon or find a prince or princess you are a lot more likely to get burned or for your ideal partner to turn out to be a frog.

As is often the case, a technology-driven innovation creates a disruption to a sector, powerful institutions with lots of money bankroll the project and new users sign up in the hope for access to a better way of doing things, but without regulation, the initial fairytale soon turns into something far scarier.

For Robinhood and their feather head followers to make this a happy ending everyone needs to understand that investing is best not done on a short term basis or with money you don’t have but what is also needed is for initiatives like preferable options for those that lack access and guaranteed low fee options with safeguards for risk should be put in place and finally that the investment industry ensures that more get to benefit from their financial wizardry.

In the audio above a reference was made about the arrest of John McAfee. The reports of wrongdoing are allegations and have not been proved as yet.

7 October 2020 7:15 PM

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