Beware of Those Offering Free Retail Trades


We are always suspicious when somebody offers us something for free.  Usually, the one offering the free service has other ways of making money.  For example, Google offers lots of free services like Gmail, Google Maps or Youtube. While the services are free, Google is still making money by targeting ads and selling data.

The latest free thing which is creating quite a buzz (the hot term for this is “disrupting”) is free retail trading by a company called Robinhood.

What is Robinhood?  According to an article in the Irish Times yesterday:

“Founded by Stanford mathematics graduate Vlad Tenev and  Baiju Bhatt last year, Robinhood is a stock brokerage that charges no commission.”

Robinhood is offering free stock trades and no-cost real time market data.  How do they do it? According to the company:

– They don’t have brick and mortar companies and don’t spend millions on Superbowl ads.

– Technology has allowed them to eliminate much of the human intervention and paper confirms.

And how do they make money?  According to their website:

“Robinhood has two key revenue streams; charging interest for margin trading, and collecting interest on cash balances.”

Call us crazy but relying on generating revenue from margin interest and collecting interest on cash balances (where the account minimum is $0) sounds a bit risky and overly ambitious in a market which has been saddled with zero percent interest rates for the past 5 years.  That’s why we think Robinhood must have another way of making money. Could it be that the founders, Vlad and Baiju, are planning on taking advantage of the rebates and payment for order flow that are embedded in the equity market?  But how could two guys who graduated from Stanford in 2008 know that much about the market structure of the US equity market? From their website:

After graduating from Stanford, roommates Vladimir Tenev and Baiju Bhatt moved to New York, where they built high-frequency trading platforms for some of the largest financial institutions in the world. They began to realize that electronic trading firms pay effectively nothing to place trades in the market yet charge investors up to $10 for each trade — and thus the idea for Robinhood was born. They soon ventured back to California to begin solving the problem of democratizing access to the markets.”

Seems like Vlad and Baiju know a lot more about US equity trading than we thought.  Heck, they may even know that when a retail limit order is sent to the DirectEdge stock exchange, that order could qualify for a special rebate if it is attributed and displayed as a retail order.  Here is how DirectEdge describe their retail attribution program​ :

“With this improvement, Members sending Retail Orders may elect to display those orders on the EdgeBook Attributed data feed with the generic retail identifier “RTAL” rather than their Market Participant ID (MPID).  Including a standard retail identifier gives retail brokers greater flexibility and choice to participate in the attribution program that has helped improve execution rates for retail orders.”

Talk about leading the lambs to the slaughter.  Retail orders that are being attributed are basically flashing bright lights telling the world that they are retail.

We’re not sure if Robinhood is planning on selling their order flow but it is certainly something that their customers should be asking them once they do start trading. While their website does not say anything about payment for order flow, in a CNBC interview from earlier this year, Vlad Tenev did say the company would be accepting payment for order flow:

 “So, Robinhood has many revenue streams on Day One. Those include margin lending, payment for order flow, interest on cash balances. We’ll have those on Day One,” Tenev said on CNBC’s “Halftime Report”.

Right now, Robinhood is still busy attracting some high profile investors which include Snoop Dog, actor Jared Leto, the venture capital fund Andreessen Horowitz and Google Ventures (Robinhood raised $13 million in their latest financing round).