Back to top

Image: Bigstock

Robinhood's Commission-Free Trading Platform: Is It Really Free?

Read MoreHide Full Article

Overview

The Robinhood trading platform has grown an enormous amount of popularity amongst millennials. Commission-free investing is something that no one would have thought was possible 5 years ago before Robinhood launched in 2014. Now Robinhood is one of the biggest trading platforms with more than 6 million users. The platform allows you to trade stock, ETFs, options, and cryptos in the palm of your hand without paying the traditional $5-$10 commission charge.

There is no question why a commission-free trading phone application gained so much popularity among millennials. Robinhood is an easy way for young individuals or first time investors to buy a couple of shares of some of their favorite brands like (AAPL - Free Report) , (SBUX - Free Report) , (LULU - Free Report) , (FB - Free Report) , (TSLA - Free Report) , etc. The average balance in these accounts ranges from $1,000 - $5,000, according to JMP Securities. Most of the investors on Robinhood are people who are just trying to get there feet wet in the markets and have a little bit of fun with their money without commissions eating into their profits.

 

Profit Structure

The real mystery behind Robinhood’s commission-free platform is how they make money with no fees. One way is through “Robinhood Gold” which allows investors with over $2,000 in their account to trade on margin. This membership starts at $6/month, and allows you to take margin up to 50% of your portfolio value. The platform also makes money from the idle funds uninvested in accounts, lending this money out and accruing interest.

Robinhood’s largest revenue driver for this business is the way they execute trades. Essentially Robinhood takes your orders and sells them to high-frequency market makers. The company claims that they are only making a minimal amount off of order flow “rebates” with market makers, but Bloomberg analyzed their SEC filings and calculated that nearly half their income is come from these order flow rebates. Robinhood is somehow able to generate 10 times the amount of revenue as traditional brokers do with this order flow method.

This method of driving revenue is toeing the line of legality and likely isn’t going to be sustainable with regulatory changes. There are also a lot of questions about whether orders executed are being front-run. Front running is the act of a broker or trader buying (or selling) shares for their personal account before completing a trade for a client that they know will move the market price up (or down). This is illegal but almost impossible to prove because of how fast high-frequency trading has become.

Despite legal concerns, Robinhood has been able to amass a number of prominent investors including Google’s (GOOGL - Free Report) VC segment Capital G. After its latest round of funding Robinhood is now valued at $6 billion with total funding up to $539 million.

Conclusion

All in all, Robinhood is a handy tool for novice investors or those without a lot of capital. What I will say from personal experience is that orders are always filled a few cents worse than I original executed the trade at (unless I set a limit order). A few cents per share isn’t going to make a difference on my ten shares, but it could cost a significant amount more than the traditional $5-$10 commission if you are trading a high volume.

Robinhoods biggest competitors include E-Trade (ETFC - Free Report) , TD Ameritrade (AMTD - Free Report) , and Charles Schwab (SCHW - Free Report) . As you can see in the 5-year chart below, all three of these stocks’ performance track together with E-trade out pacing the other two. Robinhood at 6 million users at the end of 2018, just passed the 4 million user base that E-Trade has been boasting and is fast approaching the roughly 11 million people that both TD Ameritrade and Charles Schwab service.

 

 

 

Zacks' Top 10 Stocks for 2019

In addition to the stocks discussed above, would you like to know about our 10 finest buy-and-holds for the year?

Who wouldn't? Our annual Top 10s have beaten the market with amazing regularity. In 2018, while the market dropped -5.2%, the portfolio scored well into double-digits overall with individual stocks rising as high as +61.5%. And from 2012-2017, while the market boomed +126.3, Zacks' Top 10s reached an even more sensational +181.9%.


See Latest Stocks Today >>