The Triumph of Dumb Money

Illustration by Ben Hickey

Illustration by Ben Hickey

It may be a “digital boiler room,” but Robinhood mostly won 2020. Does a reckoning await?

A deadly pandemic has you stuck at home and out of work. You’ve finished watching Tiger King, and trading turnips on Animal Crossing’s Stalk Market no longer has the same thrill.

Your phone pings. A friend has sent you a free stock on an app called Robinhood. You sign up. Flush with larger-than-usual unemployment checks and incentivized by zero-commission trades and endless in-app bells and whistles, you begin to trade. And trade. And trade. Your latest buy? GameStop.

For thousands of Americans last year, a version of this scene played out, sparking a retail investment renaissance that rivals that of the late ’90s, according to industry experts.

Professional investors were not pleased.

Criticizing Robinhood and its customers for outages and poor investment decisions became almost a sport for fintwiterati and industry experts alike in 2020.


Back in June, Omega Advisors founder Leon Cooperman said on a CNBC segment that Robinhood traders’ speculation would “end in tears.” The same month, venture capital darling Chamath Palihapitiya criticized the app on Twitter for using payment for order flow to keep trading free for customers.

But it turns out that these professionals needed retail investors: As professionals fled the market in February, Robinhood traders bought up stocks, acting as a market-stabilizing force, according to observers.

The phenomenon was tracked by researchers Simon Glossner and Pedro Matos at the University of Virginia and Stefano Ramelli and Alexander Wagner at the University of Zurich.

They looked at how institutions managed their investments during the first wave of the pandemic. By and large, allocators were “rushing to exit” the markets, Matos says. So who was buying those assets? “That led us to Robinhood,” according to Matos, who spoke with Institutional Investor by phone.

Data from the app confirmed that retail investors acted as liquidity providers for institutions, buying up the assets that allocators were selling off. “Our evidence finds that investors acted as a small but market-stabilizing force,” Matos notes.

Asked via email about this dynamic, Robinhood chief executive officer and co-founder Vlad Tenev says that the company is proud to bring new investors into the market: “The very people who had been shut out of investing have now finally found a home.”

He adds, “Across all brokerages stock ownership is younger and more diverse than it was when Robinhood was founded.”

That fact — along with trading outages and how Robinhood makes its money — is exactly what has so-called industry experts so worried.

Banks of lights go on one at a time, revealing a man sitting in an empty office. He asks the audience: “You ever think about trading stocks?” He goes on to highlight the high cost of trading — “usually up to ten bucks for every single trade.”

Enter Robinhood, the subject of this 2013 ad and the first brokerage firm to offer zero-commission trading. In the less-than-two-minutes-long advertisement, the man executes a trade. “People like us can trade just like the big guys,” he says. “With Robinhood.”

When Pacific Capital’s director of investments, Darin Tuttle, first heard of Robinhood, it was from that advertisement. “I went ‘Wow, this is the best thing since sliced bread,’” Tuttle says by phone. “No one has ever done zero-commission trades before.”

He downloaded the app the next day. Tuttle was working for the Vanguard Group at the time, so he already knew investing. He poked through the investor education information on the app soon after downloading it. It became clear to him that “the investor education descriptions were so basic and diluted that I knew the people working on the app didn’t know what they were talking about.”

Tuttle deleted the app.

Yet his interest in Robinhood hasn’t faded. One of the interns at his firm trades outside of work on the app, so Tuttle began coaching him on the process. He helped the intern create a trading journal, encouraged him to take screenshots of charts and research, and set criteria for choosing an investment: two lines of rationale per trade.

“I want him to keep doing it,” Tuttle says. “If you make money on Robinhood, more power to you.”

The problem, though, as online forums lay bare, is that many are losing — rather than making — money on Robinhood.

A year before Robinhood launched, Reddit users set up r/wallstreetbets, a subreddit about the stock market popular among retail investors and day traders.

Since the subreddit’s inception, an online community of retail investors has exploded, taking to Twitter to hype their favorite trades using the site’s cashtag function, which allows users to search using a stock’s ticker paired with a dollar sign rather than a hash symbol. Nowadays traders don’t use just Twitter to talk stocks. They’re on Discord, TikTok, and Instagram, among other platforms.

Retail investing influencers have emerged, too. Some stream themselves buying and selling stocks; others share their picks on private Discord servers that followers must pay to secure access to. For Robinhood influencers there’s another advantage: The app offers free stocks to those who get their friends to sign up.

In some cases, these influencers will use their stardom to push certain stories on a stock, says Godefroy Schrago, a partner at hedge fund research firm Sanostro. “It creates a kind of digital boiler room where you cannot really prove that it’s a coordinated way to push specific stocks,” he says.

Godefroy explains that retail investing influencers offer similar information to paying subscribers and to followers — they just target the paying subscribers first. The influencer will buy a stock, then tell his or her premium subscribers about it. Those subscribers buy the stock, and only then does the influencer share the stock pick on social media.

“They manage to really move the markets with the tweets,” Godefroy says, adding that in his view, “the problem is the relevant information becomes not what the company says, but what one specific influencer says about an announcement.”

The misinformation that spreads online has had real-life consequences. For some, financial ruin followed risky investments, overleveraging, and options trading. For one, the consequences were fatal.

On June 12 this past summer, in Naperville, a suburb west of Chicago, Alex Kearns saw that he was more than $730,000 in the red on his Robinhood account — likely a temporary balance resulting from leverage and unsettled stocks. But Kearns didn’t know that. That day he died by suicide.

A flurry of negative attention followed. But Robinhood’s critics don’t focus just on retail investors’ inexperience and the real-life fallout that can have. They cite concerns about how the company makes its money.

“It wasn’t clear until a couple of years ago how they were offsetting the free trades,” says Dr. Richard Smith, chief executive officer at the Foundation for the Study of Cycles.

Instead of charging customers to make trades, Robinhood uses payment for order flow, a process by which a market maker pays a preset fee (in Robinhood’s case, less than a penny per executed trade) to the broker. According to Securities and Exchange Commission Rule 606 disclosures, it’s a practice said to have been pioneered by Bernie Madoff and used by Fidelity, e*Trade, Charles Schwab, and TD Ameritrade, among others.

That didn’t stop Robinhood from being flamed on Twitter after Zero Hedge published a report on the subject. Billionaire investor Palihapitiya tweeted that the practice was “shady AF” and would “f––– over” retail traders.

Smith notes that Robinhood comes from a Silicon Valley mindset, where an app’s users, rather than the app itself, are its product. “They’re highly incentivized to drive customers into trades and transactions, period,” he says. “When a customer trades, they make money.”

As I was working on this story, I downloaded Robinhood and opened a small portfolio. From my limited experience, it appears Smith is right — there is not much friction in the trading process. It took little time and effort to fund my account and buy shares. Robinhood sends me push notifications when the stocks I buy make big moves, prompting me to look at the app, where I’m faced with the decision of whether to hold the stock or sell. When I’m looking at a stock’s information on Robinhood, the trade button is always within reach, sitting exactly where my right thumb hovers before I scroll.

“We firmly disagree with claims that our platform is ‘gamified,’” a spokesperson for Robinhood says via email, adding: “It is important to distinguish between accessible, modern design and gamification. For younger generations archaic platforms can equally be a barrier to investing as trade commissions and account minimums.”

This isn’t the first retail investment boom. “We saw something fairly similar happen years ago with e*Trade and Schwab that disrupted the retail broker space,” says Kim Muhota, head of financial services, North America, at global consulting firm SSA & Co.

“In the ’90s the ability to trade quickly was a novel idea,” he adds. But when the tech bubble burst in 2000, retail traders lost a lot of money.

“You had a generation of retail investors and day traders who got badly burned and wanted nothing to do with the market going forward,” says Adam Sender, founder of investment management firm Sender Company & Partners.

“When Robinhood and these other platforms went to zero commissions, it made it tempting for retail investors to trade stocks and options and take a chance again,” he adds.

Case in point: GameStop, the brick-and-mortar video game retailer that is quickly being replaced by online gaming marketplaces like Steam. Despite this, GameStop’s stock — which had been trading at about $40 last week — shot up 62 percent Friday, triggering a circuit breaker.

The rally continued on Monday, when shares closed up 18 percent.

Although there are some legitimate reasons for a price spike (ex–Chewy CEO Ryan Cohen made a large investment in the retailer and has since been added to its board), the massive upswing has been attributed to retail investors.

And even if they lost out, the retail crowd is, as some put it, in it “for the meme.” To wit: One of r/wallstreetbets’ top posts on Monday was made by someone looking for flair (Reddit’s tagging system) for buying GameStop’s stock at its peak.

As one commenter put it: “Classic GameStop. Buy at full price, return for a fraction of what you paid.”

Says Sender, “That’s the great thing about trading some of these companies today; valuation doesn’t matter. It’s all about greed and fear now. Human emotion is a major factor in the market again — just like the late ’90s.”

Sender had his first go-round with investing during that period, having worked at S.A.C. Capital before striking out on his own and starting a firm called Exis Capital Management. He followed how retail investors traded and made decisions informed by their habits.

“I wouldn’t be as disrespectful as to call them dumb money, but there are a lot of professionals who do,” he says.

Exis Capital shut down in 2014, but two years later, Sender returned to the market with his actively managed hedge fund. Nowadays the firm, which manages nearly $200 million in assets, tracks Twitter and blogs for intel on how retail investors trade. It’s not the only way Sender makes trading decisions, but it’s certainly part of the equation.

“The last ten years have been very difficult for active managers because we’ve been in a low-VIX world dominated by ETFs and quants,” he says. Yet for his firm, 2020 ended up being quite successful: It was up 69.39 percent, net of fees, according to a spokesperson for the investment manager.

Sender isn’t the only institution using retail investment information to trade.

According to Tuttle, retail investors have also added liquidity to the options market, helping Pacific Capital’s team shape forecasts. This new reality changed how his team looks at options trading, because they can fill orders more quickly. “There’s liquidity everywhere for options interest, and a lot of it is fueled by Robinhood,” Tuttle says.

But for Robinhood, 2020 ended on a sour note. In December the company was hit with a lawsuit from the Massachusetts secretary of the Commonwealth that alleged that the company was targeting inexperienced investors using gamification.

“Once individuals become customers, Robinhood relentlessly bombards them with a number of strategies designed to encourage and incentivize continuous and repeated engagement with its application,” the complaint says, noting that Robinhood “rewards its customers with colorful confetti raining down their screens” after they trade.

Says a company spokesperson via email: “We disagree with the allegations in the complaint by the Massachusetts Securities Division and intend to defend the company vigorously. Robinhood is a self-directed broker-dealer and we do not make investment recommendations. Over the past several months, we’ve worked diligently to ensure our systems scale and are available when people need them. We’ve also made significant improvements to our options offering, adding safeguards and enhanced educational materials.”

Also in December, the SEC charged the company with misleading investors about its revenue sources, particularly payment for order flow. Robinhood paid a $65 million fine and didn’t admit to or deny its involvement in the practices.

“The settlement relates to historical practices that do not reflect Robinhood today,” says the company’s chief legal officer, Dan Gallagher, via email. “We recognize the responsibility that comes with having helped millions of investors make their first investments, and we’re committed to continuing to evolve Robinhood as we grow to meet our customers’ needs.”

Robinhood’s Tenev credits the app with making investing more “culturally relevant.”

And he has lofty goals for this year. “As we look forward to 2021, we’re all in on building on the important work we’ve already undertaken,” he says. “There is much to be done to right the ship that is America. We’re committed to doing our part.”

Robinhood’s users are glad the app is doing so — at least they will be as long as stocks go up.