“He would have nightmares”
Robinhood has lured young traders, sometimes with devastating results
Richard Dobatse, a Navy medic in San Diego, dabbled infrequently in stock trading. But his behavior changed in 2017 when he signed up for Robinhood, a trading app that made buying and selling stocks simple and seemingly free.
Dobatse, now 32, said he had been charmed by Robinhood’s one- click trading, easy access to complex investment products, and features such as falling confetti and emoji- filled phone notifications. After funding his account with $ 15,000 in credit card advances, he began spending more time on the app.
As he repeatedly lost money, Dobatse took out two $ 30,000 home equity loans so he could buy and sell more speculative stocks and options, hoping to pay off his debts. His account value shot above $ 1 million this year — but almost all of that recently disappeared. In July, his balance was $ 6,956.
“When he is doing his trading, he won’t want to eat,” said his wife, Tashika Dobatse, with whom he has three children. “He would have nightmares.”
Millions of young Americans have begun investing in recent years through Robinhood, which was founded in 2013 with a sales pitch of no trading fees or account minimums. The ease of trading has turned it into a cultural phenomenon and a Silicon Valley darling, with the startup climbing to an $ 8.3 billion valuation. It has been one of the tech industry’s biggest growth stories in the recent market turmoil.
But at least part of Robinhood’s success appears to have been built on a Silicon Valley playbook of behavioral nudges and push notifications, which has drawn inexperienced investors into the riskiest trading, according to an analysis of industry data and legal filings, as well as interviews with nine current and former Robinhood employees and more than a dozen customers. And the more that customers engaged in such behavior, the better it was for the company, the data shows.
More than at any other retail brokerage firm, Robinhood’s users trade the riskiest products and at the fastest pace, according to an analysis of filings from nine brokerage firms by research firm Alphacution for The New York Times.
In the first three months of 2020, Robinhood users traded nine times as many shares as E- Trade customers and 40 times as many shares as Charles Schwab customers, per dollar in the average customer account. They also bought and sold 88 times as many risky options contracts as Schwab customers, relative to the average account size, according to the analysis.
The more often small investors trade stocks, the worse their returns are likely to be, studies have shown. The returns are even worse when they get involved with options, research has found.
This kind of trading, in which a few minutes can mean the difference between winning and losing, was particularly hazardous on Robinhood because the firm has experienced an unusual number of technology issues, public records show. Some Robinhood employees, who declined to be identified for fear of retaliation, said the company failed to provide adequate guardrails and technology to support its customers.
Those dangers came into focus in June when Alex Kearns, 20, a college student in Nebraska, killed himself after he logged into the app and saw that his balance had dropped to negative $ 730,000. The figure was high partly because of some incomplete trades.
“There was no intention to be assigned this much and take this much risk,” Kearns wrote in his suicide note, which a family member posted on Twitter.
Like Kearns, Robinhood’s average customer is young and lacks investing know- how. The average age is 31, the company said, and half its customers had never invested before.
Some have visited Robinhood’s
headquarters in Menlo Park, Calif., in recent years to confront the staff about their losses, said four employees who witnessed the incidents. This year, they said, the startup installed bulletproof glass at the front entrance.
“They encourage people to go from training wheels to driving motorcycles,” Scott Smith, who tracks brokerage firms at financial consulting firm Cerulli, said of Robinhood. “Over the long term, it’s like trying to beat the casino.”
At the core of Robinhood’s business is an incentive to encourage more trading. It does not charge fees for trading, but it is still paid more if its customers trade more.
That is because it makes money through a complex practice known as “payment for order flow.” Each time a Robinhood customer trades, Wall Street firms actually buy or sell the shares and determine what price the customer gets. These firms pay Robinhood for the right to do this because they then engage in a form of arbitrage by trying to buy or sell the stock for a profit over what they give the Robinhood customer.
This practice is not new, and retail brokers such as E- Trade and Schwab also do it. But Robinhood makes significantly more than they do for each stock share and options contract sent to the professional trading firms, the filings show.
Vlad Tenev, a founder and co- chief executive of Robinhood, said in an interview that even with some of its customers losing money, young Americans risked greater losses by not investing in stocks at all. Not participating in the markets “ultimately contributed to the sort of massive inequalities that we’re seeing in society,” he said.
Tenev has said Robinhood has invested in the best technology in the industry. But the risks of trading through the app have been compounded by its tech glitches.
In 2018, Robinhood released software that accidentally reversed the direction of options trades, giving customers the opposite outcome from what they expected. Last year, it mistakenly allowed people to borrow infinite money to multiply their bets, leading to some enormous gains and losses.
Robinhood’s website has also gone down more often than those of its rivals — 47 times from March to early July for Robinhood and 10 times for Schwab — according to a Times analysis of data from Downdetector. com, which tracks website reliability. In March, the site was down for almost two days, just as stock prices were gyrating because of the pandemic. Robinhood’s customers were unable to make trades to blunt the damage to their accounts.
Dobatse suffered his biggest losses in the March outage — $ 860,000, his records show.