Investing

Did Robinhooders Expose a Fatal Flaw in High-Frequency Trading With GameStop?

The stock market’s meteoric rise despite COVID-19 has more people getting interested in trading. It hasn’t been hard for many new traders to make a couple bucks since last April, at the height of the pandemic, and many are now considering themselves experts. Playing in a bull market propelled by the Federal Reserve is one thing, but some of these traders may in fact be the new experts.

The economy crashed between late-February to April as a result of pandemic-prompted shutdowns. However, this did provide a good entry point for many new investors. Also with more time spent at home, there has been ample time for many to acquaint themselves with the stock market as a means of making some cash on the side.

One of the main vehicles for investment has been Robinhood, a trading app that boasts a user base of over 13 million, according to the New York Times. Although this is one of a few trading platforms that new investors have chosen, it provides an interesting trading perspective, as the name would suggest.

Legend paints Robin Hood as one who takes from the rich and gives to the poor, and that seems to be the sales pitch for this app as well. However, in recent years this trading platform has been marred by accusations of potentially gouging its clients. After Monday’s trading session this idea may be put to rest.

The company that services Robinhood trades, Citadel, is known as a high-frequency trading (HFT) firm. Such firms look to earn the bid-ask spread (the difference between what the buyer and seller are asking) by making a set of high-frequency trades. Many people have taken issue with Citadel in the past for what some consider to be underhanded trading practices.

Note that, about a month ago, Robinhood settled charges with the SEC with regards to misleading its investors.

So there has been a debate surrounding this for a while. Robinhood offers zero-commission trades and was one of the very first platforms to do so, but in the process, the firm ran its order flow through HFT firms like Citadel. In short, there are some advantages and disadvantages to this.

Only recently did the SEC order find that one of Robinhood’s selling points to customers was that trading was “commission free,” but due in large part to its unusually high payment for order flow rates, Robinhood customers’ orders were executed at prices that were inferior to other brokers’ prices. Even further, the order found that Robinhood provided inferior trade prices that in aggregate deprived customers of $34.1 million, even after taking into account the savings from not paying a commission between the years of 2015 to 2018.

Here’s where the little guy fought back. Many traders on the Robinhood platform often take risky positions, and many are looking to play options as a way to get rich quick, as opposed to more traditional investing or trading methods.

There’s a whole community around this that celebrates wins, laughs at losses and shares memes on Reddit. They’re known as r/WallStreetBets. You can find many of these guys on Twitter sharing memes or the latest stock tips, some even trolling. It’s hard to take any one person seriously in this community because, at the end of the day, they’re only avatars on Twitter or Reddit. Regardless, the force is real.