How Robinhood Actually Makes Cash, and Why It No Longer Issues

Whereas evidently Robinhood and Gamestop are formally the brand new playing model of a multiplayer on-line online game (CNBC, BI, Bloomberg), this story jogged my memory of this previous Matt Levine article which is my favourite detailed-yet-understandable clarification of how Robinhood makes cash. There have been many related makes an attempt to elucidate their enterprise mannequin, however this felt probably the most balanced. Even the footnotes are instructional.

For instance, he explains how the most important brokers like TD Ameritrade used to deal with fee for order circulate, which you possibly can equate to a reduction on the inventory value (“value enchancment”):

“We’ll purchase inventory for you, you’ll pay us $5 to do it, we’ll get a reduction on the inventory and we’ll move on 80% of the low cost to you.”

Examine this with how Robinhood selected to do deal with fee for order circulate:

“We’ll purchase inventory for you, you received’t pay us to do it, we’ll get a reduction on the inventory and we’ll move on 20% of the low cost to you.”

Robinhood additionally occurs to receives a commission extra for his or her order circulate than different brokerage companies. I’ve additionally explored this query again in 2018: Does Robinhood Brokerage Make Cash in Shady or Questionable Methods? My fundamental conclusions had been that:

  • Robinhood could be breaking the legislation in the event that they broke the SEC rule of Nationwide Finest Bid and Supply (NBBO) that requires brokers present the perfect obtainable bid and ask costs when shopping for and promoting securities for patrons. They wouldn’t do this, would they?
  • The order circulate from Robinhood might be extra helpful as a result of it’s from small, retail buyers (“dumb cash”).

Nicely, it seems that:

  • The SEC did the truth is declare that Robinhood broke the legislation by not offering the perfect obtainable inventory costs to its clients. Robinhood paid a $65 million penalty to settle this declare in December 2020. See: SEC Fees Robinhood Monetary With Deceptive Clients About Income Sources and Failing to Fulfill Responsibility of Finest Execution.
  • Numerous trade insiders agreed that order circulate from Robinhood is certainly extra helpful as a result of all of the orders come from “dumb cash” and is thus rather more dependable for high-frequency merchants to become profitable from than order circulate from institutional clients.

In the event you don’t learn Matt Levine’s total clarification, right here is the backside line: Robinhood clients had been primarily being charged an additional roughly three to five cents a share by way of poorer execution costs. In the event you solely traded a number of shares, you then nonetheless mainly paid nothing. In the event you traded 100 shares, that may add as much as $three to $5 whole. Roughly breakeven. In the event you traded 1,000 shares, that may add as much as $30 to $50 whole. For some individuals, Robinhood’s “free trades” had been a greater deal. For others, Robinhood’s “free trades” had been a a lot worse deal.

Supposedly, Robinhood doesn’t do that anymore and satisfies NBBO once more. Nevertheless it nonetheless exhibits the final approach through which Robinhood makes cash in the present day. Excessive-frequency buying and selling companies pay considerably increased costs for the buying and selling flows from Robinhood customers, and Robinhood retains as a lot of that cash as potential whereas nonetheless barely satisfying NBBO. Maybe a smaller quantity on the order of a half-penny a share. Different companies like Constancy proudly boast of how they do higher than NBBO (“value enchancment” once more), which can be a quiet dig at Robinhood.

[Fidelity’s] value enchancment can save buyers $18.53 on common for a 1,000-share fairness order, in comparison with the trade common of $4.25.

All this now not issues as a result of Robinhood is now not the candy spot for amateur merchants. Individuals prefer to make enjoyable of the Robinhood title as a result of in a approach they secretly stole from the “poor” common merchants and bought their orders to the “wealthy”. Nonetheless, additionally they pressured everybody from Constancy to Schwab to all supply commission-free trades. Robinhood did ship one thing to us frequent folks!

The vital distinction is that companies like Constancy and Schwab nonetheless have rich shoppers that demand telephone numbers with useful people that reply after just a few rings. In the meantime, Robinhood solely gives an overwhelmed e-mail deal with than can take days or perhaps weeks to lastly deal with your issues.

When Robinhood first got here on the scene, they had been the brand new candy spot for reasonable trades for small balances. Nonetheless, now that free trades are all over the place, the candy spot in my view has now shifted to one thing like a Constancy or Schwab account. You get whole fee prices both equal to or decrease than Robinhood, plus higher customer support from extra knowledgable reps. In the event you nonetheless choose a classy new app over a stuffy previous dealer, take a look at my Massive Listing of Free Shares For New Fee-Free Brokerage Apps. Most of them have a telephone quantity, and so they’ll be much less busy. (WeBull, M1 Finance, and Firstrade for certain have telephone numbers.)

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