Robinhood – it’s a name you’ve probably seen in the news recently. Seemingly overnight, it rose from the comments of Reddit’s r/wallstreetbets to the front page of the Financial Times. It’s one of the biggest financial stories of 2021 so far – but much of the public has been left with more questions than answers. What is the Robinhood app? Why is it so controversial? And why are hedge fund managers up in arms about GameStop shares?
Understanding the GameStop short squeeze and Robinhood’s involvement isn’t for the faint-hearted. Niche concepts and financial jargon can cloud the story a little, but it’s actually simpler than it seems. Today, we’re looking at Robinhood: what it is, and why it’s in the news.
WHAT IS ROBINHOOD?
In an effort to make investing more accessible to the common individual, trading apps have begun popping up all over the place. Fidelity, E*TRADE, and TD Ameritrade are just a few of the most well-known.
While Robinhood Markets, Inc., the company behind Robinhood, was founded in 2013, the app itself was launched in 2015. Since then, it has gained a reputation as r/wallstreetbets’ trading platform of choice.
With a simplified interface and no commission, it’s an attractive prospect to new retail investors. Its main user base consists of individuals with little financial literacy.
In short, Robinhood is an easy way for investing beginners to buy and sell stocks and other financial instruments. It operates as a commission-free brokerage and allows 0$ account minimums.
You can probably tell from the name that Robinhood was intended to be an ‘app of the people’. In Robinhood’s view, stock trading had always belonged to the rich. The world of Wall Street was an exclusive one, and anyone seeking their fortune there required financial expertise and a lot of money.
Robinhood set out to change that. They aimed to bring trading to the masses, giving everyday people the opportunity to buy and sell shares. Their website claims:
“Our goal is to make investing in financial markets more affordable, more intuitive, and more fun, no matter how much experience you have (or don’t have).”
And for years, this goal was achieved. The app was a success, amassing users and gaining something of a cult following. It now has over 10 million downloads under its belt.
Ordinary people were Robinhood’s focus, and it was there to support them in their financial endeavours. That is until the price of GameStop shares began to swell.
WHAT HAPPENED WITH GAMESTOP?
GameStop Corp. (GME) is an American high-street video game retailer. For a while now, and especially since the Covid-19 pandemic began, it has been struggling to stay afloat. There is nothing special about the company itself, though its shares are a different story.
For most of 2020, GME stock prices had been stagnating in the $5-15 range, until it skyrocketed in late January 2021. On January 27th, the closing price was an astronomical $347.51. As of the time of writing, the GME stock price is $51.10.
And it’s all down to one Reddit forum.
WHAT IS R/WALLSTREETBETS?
Founded in 2012, r/wallstreetbets is an online community of Redditors with an interest in stock trading. Its users are mostly young and inexperienced retail investors, who see investments as a way of getting as rich as possible, as soon as possible.
It is, by no means, a serious forum. Members make risky investments, ignoring almost all expert advice, and viewing their actions as a form of gambling. Inside jokes, meme stocks, and tremendous losses are all part of the fun.
In January 2021, provoked by reports that GME stock would decrease in value, users decided to carry out a short squeeze. With thousands of investors buying up shares, the price climbed to over $500.
Robinhood was hugely important to the r/wallstreetbets community. It was their main trading platform, and the one they used to buy most of their GameStop stock. So, when Robinhood banned the trading of GME stock at the height of the squeeze, it was viewed as betrayal.
WHAT IS A SHORT SQUEEZE?
While investors usually make money off of rising prices, they can also profit from a fall. Short sellers do this by borrowing shares from a lender, then selling them. Once the share price falls, they buy back the same shares at a lower price. They then return the shares, with interest, to the lender, having made a profit themselves.
If a short seller sells their borrowed shares and the price rises, they’re in trouble. They still owe the lender those same shares, so they’re forced to buy them back at a higher price. The short seller suffers a loss.
This was the intention of r/wallstreetbets. They wanted to boost GME prices and push back against hedge fund managers attempting to short sell GME stock. Partly out of sentimentality towards the store that sold them their childhood video games, partly out of a desire to ‘stick it to the man’. Many of these individuals and their families also experienced the 2008 Global Financial Crisis (GFC), where over 2.3 million foreclosures occurred. This was also part of the motivation for these retail investors to come together and show the power of unity and collective action among everyday individuals. They succeeded, and short-sellers lost an estimated $70 billion.
ROBINHOOD’S STOCK RESTRICTIONS
Once Robinhood caught on to what was happening, they suspended the buying of GME stock. Then promptly restricted the trading of other stocks that r/wallstreetbets had in its sights, such as AMC and Blackberry.
While most other app-based stock brokerages had done the same, Robinhood has been the target for much of the backlash from retail investors. Scathing reviews, social media hate, and an exodus of users quickly followed the restrictions. Robinhood’s app rating sharply fell to a one-star rating, with over 100,000 one-star reviews following these restrictions (later being removed by Google).
As the platform used by most r/wallstreetbets users, this is not surprising. The intentional outage also conflicted with Robinhood’s supposed belief in unrestricted trading for everyday people. As the name suggests, take from the rich and give to the poor.
WHY DID ROBINHOOD RESTRICT THESE STOCKS?
As users grew more frustrated with Robinhood, rumours began circulating on social media. Many believed that the brokerage had halted trading to protect their own rich shareholders.
In fact, Robinhood claimed that their actions were mere risk management. As the buying frenzy took off and non-Reddit users joined in, the company had a problem. When share prices – inevitably – crashed, a lot of people were going to lose money. A lot of people were going to blame Robinhood.
In their view, they froze trading to protect themselves and their users. Was it sensible? Yes. Did this explanation calm anyone down? No.
Two weeks after the GameStop short squeeze, Robinhood is only just surviving. Faced with multiple lawsuits and the death of a 20-year-old user, its troubles are far from over. It managed to raise over $1 billion from its investors once the dust settled, but will this be enough? As with everything else in the world of stocks, only time will tell.