Tags: blame | fed | robinhood | trading | blitz

Don't Blame the Fed for the Robinhood Trading Blitz

Don't Blame the Fed for the Robinhood Trading Blitz

(Dennizn | Dreamstime.com)

Jared Dillian By Thursday, 18 June 2020 04:01 PM EDT Current | Bio | Archive

Optimism is plentiful in the various online forums such as Reddit’s r/wallstreetbets where the fast-growing number of small investors discuss stocks.

There you’ll find little to no discussion of betting against equities —  even those of bankrupt companies — following the S&P 500 Index’s remarkable 39% gain from its low this year in late March. The head cheerleader for these legions of day traders is Dave Portnoy, the founder of the website Barstool Sports, who has attracted a wide following by live-streaming his trading exploits.

Why should anyone care about a bunch of market neophytes opening up accounts with the Robinhood investing app to trade stocks? Because the last time we saw such a frenzy of retail participation was during the dot-com mania 20 years ago, which ended in a spectacular bust. I’m happy that people have taken an interest in financial markets, just not to the degree that we have seen lately.

Among professional investors, the proximate cause of this speculation is the Federal Reserve, which has provided an astounding amount of liquidity to support the economy and the functioning of financial markets, slashed its benchmark interest rate to zero, pledged unlimited quantitative easing and to buy a range of risky assets. Its balance sheet assets have soared from $4.16 trillion in late February to $7.17 trillion as of last week.

The Fed may be a convenient scapegoat, but the real villains are the discount brokers, which cut their trading commissions to zero last year. Millennial-focused Robinhood saw 3 million new accounts opened in the first quarter alone. Average trading volume at E-Trade and TD Ameritrade combined has gone from about 1 million trades per day in 2018 to 4 million today, according to Jason Goepfert, the president and chief executive officer at SentimenTrader, an independent investment research firm dedicated to the application of mass psychology to the financial markets.

Basic economics teaches that the demand curve slopes downward. If something is cheap or free, people will demand more of it. To be sure, eliminating commissions wasn’t part of a larger strategy to get people to trade more; it was simply a matter of market forces and capitalism driving prices lower. But it has had catastrophic effects, luring millions of unsophisticated people into the stock market, where they will most likely lose money that they can’t afford to lose.

Commissions actually only ever represented a small part of a discount brokerage’s revenue, something less than 20%, according to various studies. The bulk of their revenue, or about 60%, comes from net interest income, which is when they take their cash balances and reinvest them in low-risk securities that yield a bit more. The rest comes from securities lending and payment for order flow, which his how trades are routed to electronic market-makers. We have learned over the years that it can be very profitable to bet against retail trades, and firms that specialize in making markets have been willing to pay handsomely for access to those trades. Out of all the discount brokers, Robinhood receives the largest portion of its revenue from payment from order flow, or almost 10%.

A lot of people like to trot out the tired argument that reduced fees are good for investors. But what the recent episode shows is that higher commissions are actually better in that they reduce trading activity and promote buy-and-hold strategies that tend to outperform in the long term. High transactions costs are not the enemy, because they nudge investors towards optimal behavior.

Unfortunately, there is no easy remedy. It would be lunacy to pass legislation that would force brokerages to increase commissions or enforce any other top-down solution that would bar millions of unsophisticated investors from being sucked into the stock market. But if this ends badly for the newcomers -- and it almost certainly will -- it will result in even more millions of people becoming disenchanted with not only the stock market, but possibly even capitalism.

To be clear, it’s not bad that the stock market has once again captured the imagination of the broader investing public. What is so disconcerting is that people are trying to get rich fast, rather than through a methodical strategy.

The financial Darwinism of the market eventually sorts this out, but the consequences—especially in this political environment, where capitalism is already on shaky ground—could be catastrophic.

Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of 'Street Freak' and 'All the Evil of This World.' He may have a stake in the areas he writes about.

© Copyright 2024 Bloomberg L.P. All Rights Reserved.

It’s not bad that the stock market has once again captured the imagination of the broader investing public. What is so disconcerting is that people are trying to get rich fast, rather than through a methodical strategy.
blame, fed, robinhood, trading, blitz
Thursday, 18 June 2020 04:01 PM
Newsmax Media, Inc.

Sign up for Newsmax’s Daily Newsletter

Receive breaking news and original analysis - sent right to your inbox.

(Optional for Local News)
Privacy: We never share your email address.
Join the Newsmax Community
Read and Post Comments
Please review Community Guidelines before posting a comment.
Get Newsmax Text Alerts

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

© Newsmax Media, Inc.
All Rights Reserved
© Newsmax Media, Inc.
All Rights Reserved