Why I Might Ditch Robinhood

A short review of Robinhood’s pros, cons, and handling of recent events.

Like many of you, I use Robinhood to trade stocks and ETFs. The layout of the app is simple, user-friendly and a great way for novice investors to get their foot in the door. Perhaps the biggest appeal to new investors is that the app does not charge a commission fee on trades. Robinhood has made investing far less intimidating for the average Joe, which is great, but recently it did something that raised a major red flag.

It probably won’t come as a surprise that I am referring to how the trading platform handled the rise and fall of stocks like GameStop (GME) and AMC Entertainment (AMC). I have seen and read a lot of content online about the situation, but have not heard much from other users. I see myself as the “typical” user; someone who is relatively new to investing, in their 20s and places trades on a monthly basis. So I want to weigh in.

How It All Started

Time to put my finance degree to work and explain this situation best I can! Back in January, hedge funds across the country were betting on stocks like AMC and GME to decline in price. Recent turbulence caused by management and the pandemic showed signs that the companies would not have a favorable February.

In light of this, a few hedge funds decided to short both stocks. Shorting is when a stock is borrowed, rather than bought and the borrower agrees to buy the stock at a later date. Upon borrowing the stock, the borrower will almost immediately sell the shares in hopes that the price will decline over the next few weeks. Once the date arrives for the borrower to buy the shares off of the lender, ideally the price will be significantly lower so that the stock can be bought at a discounted price compared to what it was sold for.

In simplest terms, shorting is executed when stock prices are expected to go down, and buying (or going long) is executed when prices are expected to go up.

The process sounds straightforward enough, but there is one major caveat to shorting. It is incredibly risky. When a stock is bought, say for $50, the potential for loss is just that, $50. A stock price cannot dip below $0. When a stock is shorted however, the potential for loss is limitless. If that same stock is borrowed and sold for $50, it is possible for the price to increase to $100, $200, maybe even $1,000. If a short seller borrows a stock at $50, sells it, then has to buy the stock at $200 you can see how massive of a loss that is.

In the case of GME, the stock price went from as low as $17 in January (when shorts were initially made) to as high as $374 later that month. This obviously pissed off a lot of Wall Street bigwigs, but why did it happen?

Wall Street Bets

This major upset showed just how powerful social media platforms are today. Social media has the power to silence a sitting U.S. president, but also give a voice to millions. In this case, that voice came in the form of a popular Reddit page called r/wallstreetbets. R/wallstreetbets has roughly 9.2 million followers, who they hilariously call “degenerates,” and they utilized this fan base in an effort to show up Wall Street.

Upon reading the news of the planned shorts of stocks like GME and AMC, r/wallstreetbets rallied all their troops and encouraged them to start buying both stocks like crazy. Loyal to the cause, many followers obeyed. With millions of purchase orders suddenly flying in, both stock prices rose exponentially, and Wall Street short sellers panicked. Something had to be done to put this fiasco to an end, so Robinhood intervened.

Robinhood Halts Trading

In an unprecedented move, Robinhood decided to halt all buy orders for GME and AMC. This is where my beef arises with the trading platform. Now, I want to first clear the air and say that I have never bought or sold any shares of GME or AMC, so I do not have a dog in that fight, but I do have major concerns over what this action means for the future of Robinhood.

In my view, it was completely unethical to halt the buying of both of these stocks. In the days that followed, Robinhood sent an email to all of its users, which I received, that played off the halt of purchase orders as saving its investors from exposing themselves to high risk situations. I think that is absolute malarkey.

As an investor, the platform has no right to decide what I should and should not be able to purchase. This action seriously infringed upon a sacred agreement between investor and broker. I have no problem if a platform wants to publish articles or send emails about the dangers of purchasing or selling a security, but to take that right away completely is uncalled for.

At the same time, I am aware that this is one of the costs of using a free service. It’s sort of like using Facebook. Facebook’s service is free, but in exchange your data becomes sellable. You never pay Facebook to withhold your information from outside parties, and agree to their terms of service when you sign up. You are welcome to walk away from the service at any time, but you as an individual have very little leverage over what they can and cannot do once you agree to their terms.

Unfair? Probably. Did you agree agree to it? Yep.

Outages

In addition to this move, Robinhood has other disadvantages that platforms like E*Trade and TD Ameritrade do not. For example, In March of last year, Robinhood servers were down for an entire trading day. That meant I could not buy or sell any securities for 24 hours at a time when prices were highly volatile. It is days like this when I find it most crucial to have access to my portfolio, and all I could do was sit and watch. There have also been shorter outages that have occurred before and after the one in March of 2020.

While 99% of me is sure that this outage was caused by a lack of servers, 1% of me now ponders if maybe there was something shadier going on behind the scenes because of the actions taken this month. I am not saying that I think that is the case here, and have no proof, but since the trust between investor and broker has been frayed, I would be lying if I said I haven’t thought about it.

Lack of Diversity

While Robinhood is great for trading stocks and ETFs, it does not allow for the type of diversity and planning that other platforms offer. For example, Robinhood does not offer cryptocurrency trading in every state, nor does it offer retirement accounts like IRAs. As someone who currently has a Roth IRA open through a different platform, I want to briefly explain how it works just to show what you could potentially be missing out on.

A Roth IRA is a lot like any other investment account. You can choose to invest the money in stocks, ETFs, real estate, etc. But there is one major benefit that makes the Roth IRA special. In a traditional IRA or stock, you get taxed upon the withdrawal or sale of the investment. Instead of paying taxes when you withdraw money from a Roth, you pay an upfront tax when the money goes in. This means that after the age of 59, all of the money you extract from the Roth is tax free. While this is an extremely simplified explanation of how a Roth works, it shows that investing goes far beyond just buying and selling stocks, and other platforms are more advantageous in a lot of situations.

I’m Still Undecided

With all of this being said, I am still undecided about whether or not I will pull my money from Robinhood. I will be the first to admit that I really like the usability and styling of the app. Plus it feels cool to be a part of something that is on the cutting edge. I think that Robinhood is still figuring out what its limitations should and shouldn’t be. As a customer, I think Robinhood is acutely aware that their recent actions caused some waves. Only time will tell if the app will retain its massive user base and continue to disrupt the traditional ways of trading.