Why Robinhood Turned Into Robbinghood
Updated: Jan 29, 2021
Chances are, you have at least one friend or family member or co-worker who recently told you to buy stock in Gamestop, the brick and mortar video game retailer who recently came out with guidance they wouldn't be profitable again until 2023.
Or they told you to buy shares of AMC, the movie theatre chain that has shut its doors the past year due to COVID 19.
Or they told you to buy shares of Nokia, the phone company that brought you the best phone game of all time back in the early 2000's, snake (those of you 24 and under probably have no idea what that is).
The theme among all those companies is that they're dying. However, in the last week, these stocks, most notably Gamestop, have skyrocketed. Shares of Gamestop (stock ticker, GME) went from around $40 to a peak of $440 in just a span of a week. Had you invested $40, your investment would have brought in 10x the return at one point.
Why these dying brands all of a sudden skyrocketed could be explained in a complex, drawn out fashion. But in the most basic and simplistic terms, many Wall Street firms had shorted Gamestop. Shorting means investors (mostly Wall Street firms) borrow shares of stock to sell and then buy back later so they can return them, which lets them pocket the profit if the stock price goes down. Basically, these Wall Street firms were betting Gamestop would fail.
Users on the website Reddit, in a subreddit called, WallStreetBets, noticed how many firms were shorting Gamestop. Then, in a coordinated effort, along with one hell of a marketing campaign, urged the users of the subreddit and visitors of the subreddit to buy Gamestop stock to drive up the price. By driving up the price, it created what's called a short squeeze.
The speculative trading fueled by WallStreetBets left short sellers with no more shares to buy to cover their positions, creating a short squeeze and leaving them with millions of dollars in stocks they had bought at a high price but which they then had to offload at an even higher price.
Why are you calling Robinhood, Robbinghood?
As everyday Internet trolls began making thousands and in some cases, millions of dollars, hedge funds and other Wall Street firms were losing BILLIONS.
Robinhood is the brokerage app many folks were using to buy and sell these "meme" stocks (Gamestop, AMC, Nokia, Blackberry to name a few). Robinhood prided itself as the millennial app that was "anti-Wall Street". They were the app that was going to help the little guy and gal get rich by introducing them to the world of investing with $0 trades.
Then, unexpectedly, on the morning of January 28, 2021, Robinhood (and other brokerage apps) terminated all trading in Gamestop, AMC, Nokia and the other "meme" stocks. The only thing users were allowed to do were close out their positions (sell). The reasoning Robinhood provided was the market was too volatile and they didn't want folks to be overleveraged in these stocks.
This completely rattled the price of the "meme" stocks, instantly sending them crashing. In a country where free markets reign supreme, Robinhood and other brokerage firms manipulated the market by restricting activity on the meme stocks.
But why would the app that prides itself on being the "anti-Wall Street" help the biggest Wall Street firms stop their bleeding? This is where things get a bit complicated.
What is a market maker?
A market maker is a firm or individual who actively quotes two-sided markets of a stock/security. When you ask to buy Gamestop stock for $100 on Robinhood, it sends your bid to a market maker behind the scenes. That market maker then takes your bid and matches it with someone selling Gamestop for $100 or maybe a little less, $99.98 for instance. The market maker then sends you your Gamestop stock, sends the seller $99.98 and then keeps the 2 cents for themselves and Robinhood. This is very lucrative because billions of stocks are exchanged per day.
A lot of stocks are traded on the New York Stock Exchange (which is a market maker) but Robinhood and other retail brokerage firms, use dark pools. And in those dark pools, many high frequency trading firms are the market makers.
One of the largest market makers Robinhood uses is the high frequency trading firm, Citadel. Citadel along with another hedge fund, Point72, invested $2.75 BILLION dollars into Melvin Capital Management earlier in the week. Citadel did this because Melvin Capital had lost billions of dollars shorting Gamestop.
With Citadel now having a massive stake in Melvin Capital, they had every incentive for Gamestop stock to crash in price in order for Melvin to re-coup the 30% losses they incurred so far this year because of their large short position.
Because Citadel is the market maker for 40%-60% of the trades through Robinhood, Robinhood in theory has to rely on Citadel for Robinhood to execute trades. Robinhood NEEDS Citadel to survive for their business.
If, in theory, Citadel pressured Robinhood to halt trading on the meme stocks, it would be a blatant market manipulation tactic that would benefit Citadel because of their investment stake in Melvin Capital.
Is all this true?
Citadel being one of the largest market makers for Robinhood is true. Citadel investing billions of dollars to Melvin Capital to bail them out is true. Robinhood needing Citadel to run their business is true.
Did Citadel pressure Robinhood to halt trading on the meme stocks so that they could re-coup losses on their investments? That is speculation but where there's smoke, there's fire.
You probably should never take investment advice from someone on Reddit, You probably should never invest all your money into dying, obsolete companies.
But, for a brief second, it looked like retail investors had found a way to bleed dry Wall Street firms that have profited hand over fist at the expense of everyday Americans since forever.
Wall Street bled but unlike everyday folks, they were able to bend the rules to stop their bleeding. If there isn't an investigation done to tell the general public and the millions of Robinhood users why they restricted activity on the meme stocks, then it will only reaffirm what everyone has thought for years, the game is rigged.
With millions of retail investors losing tons of money because of Robinhood's actions, Robinhood really did turn into Robbinghood.