The Robinhood Crisis Reveals Hidden Costs in Zero-Fee Trading Model

Turns out, no-fee stock trades can exact a very high price after all.

Not only for the retail traders sitting on deep losses speculating on meme stocks, or for Robinhood, which faces recriminations for “gamifying” the frenzy that spun out of control and was forced to scramble for billions in fresh cash, but also for the stock market itself, which must reckon with the wild swings that have little bearing on fundamental value.

If the surreal events of the past week hold any lessons for investors, it’s this: that for all its benefits, the “democratization” of the stock market, powered by the no-commission model, is far from without risks. Things can quickly and recklessly devolve into mob rule.

By now, just about everyone is familiar with GameStop and its spectacular rise and fall. But in many ways, it’s merely the most prominent example of what can happen when short-term stock trading — in place of the tedious, long-term vision of passive investing — becomes free and accessible to all.

“It’s when friction decreases that you expect much more action, more trading, so going to zero in trading fees matters,” said Stephen Wendel, head of behavioral science at Morningstar. “The more frequently that people get price updates the more it warps, and changes their behavior.”

Of course, the race to zero commissions was meant to even the playing field that was all too often tilted toward the Wall Street establishment and help ordinary Americans take their financial futures into their own hands. Still, the recent episode lays bare troubling questions for not only Robinhood, which pioneered the idea that anyone, anywhere could trade the hottest, most volatile stocks and options for free, but for everyone else in the brokerage industry.

Online stalwarts like Charles Schwab, E*Trade and Interactive Brokers, which followed Robinhood in eliminating commissions, all faced disruptions or were forced to curb some transactions amid the retail trading crush.

“We’ve made gambling on the stock market cheaper than gambling on sports and gambling in Vegas,’’ said Larry Tabb, an analyst at Bloomberg Intelligence. “There’s no rake, there’s no vig.”

Today, Robinhood — which until this past week was having a banner year as cooped up millennials became addicted to its slick and game-like app — is at a crossroads. It’s had to borrow or raise billions of dollars to shore up its capital. Regulators and lawmakers plan to examine its decisions. And legions of users, feeling betrayed by Robinhood’s emergency decision to ban purchases of the popular, high-flying shares, have vowed to leave the platform as those same stocks now tumble.

Robinhood declined to comment.

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