Robinhood is a start-up brokerage company founded in 2013 in Silicon Valley which offers zero-commission trading, nice looking interface, hassle free account opening process, a free stock for every user and the availability of fractional shares. The ease of trading has made it most popular brokerage firm in the US particularly among the younger population with a valuation of $ 8.3 Billion. Huge surge in the number of accounts using Robinhood application has been witnessed post lockdown in the US. In May, this year, it had 13 million accounts, up from 10 million at the end of 2019. This huge surge in the number of accounts using Robinhood application is being mainly attributed to the closure of casinos and cancellation of major sports leagues during the lockdown which has led punters into trying their hands in the stock market. It is also reported that many who are stuck at homes due to lockdown are trying their luck by using stimulus cheques by investing in stock markets.
The company is named Robnihood after the English outlaw who stole from the rich and gave to the poor. But with the opening up of this Robinhood start-up company, the other way around is happening in the sense that the wealth of the amateur investors belonging to the lower middle class is largely being plundered. It has been found that large number of Robinhood investors have suffered significant losses. The fundamental reason for this sad state of affairs is that the people using Robinhood application are indulging in trading, that too very aggressively which inherently is very risky. With the addition of more complex products recently, like ‘Options Trading’, it has made its account holders even more prone to risk. The core philosophy of the business of Robinhood is to encourage more and more trading which is injurious to the investors. At the top of it, indulging in trading that too without understanding the complexities of the market makes it suicidal. One investor while talking to New York Times said “that they make it so easy for people that do not know anything about stocks, then you go there and you start to lose money”. Besides, many new breed of young and amateur traders have been found investing in battered and beaten-up stocks which is evident from huge price hikes in penny stocks in the US. This peculiar trend of significant movement in the valuations of penny stocks is not peculiar to the US market alone but is happening in the Indian market as well, thus indicative of “Indian Version of Robinhood Investors”.
Penny stocks are the stocks of the beaten-up or troubled companies whose value is less than Rs. 10. These stocks are illiquid, high risk and generally out of the radar of investors. But in spite of statutory warnings of staying away from the penny stocks, a peculiar trend has been observed in the Indian stock market from April during the market turnaround; good number of penny stocks have moved significantly higher, initially hitting daily circuit filters. 178 penny stocks have rallied between 100% to 1700% from 23rd March, 2020 lows. To name a few, the prices of Reliance Power, Reliance Capital, Reliance Infrastructure, Birla Tyres, Opto Circuits, Alchemist, Sintex Plastics, Andhra Cements, Alok Industries, Ruchi Infra, JMT Auto have gone way too high. Such a significant movement in good number of penny stocks is surely indicative of two disturbing events. One, that the number of new accounts that are opened and transacting have gone-up manifold over the last quarter or so. It seems that this breed of first time investors has mopped-up penny stocks without looking at the fundamentals of these companies. Second, the thrill of making a quick buck might have drawn Robinhood Investors, who are Stock-at-Home due to lockdown, towards penny stocks without knowing that these stocks are prone to manipulations due to low float, and concentration of such stocks in the hands of few investors.
Actually these new Robinhood investors are trapped in a method called “Pump & Dump” employed by the scammers to trap naive small investors. Using this method, scammers continue to purchase a considerable amount of penny stock for a certain period of time, making the stock to hit upper circuit every day. This phenomenon of hitting upper circuit number of days continuously is observed by the naive and amateur traders/investors, who follow the hype. Once enough buyers have invested in such stocks, scammers dump their shares with everyday hitting the lower circuit, making very difficult for these naive investors to move out. These investors finally sell at a price much lower than their acquisition price and even some get permanently stuck due to a behavioural constraint called “Dispossession Effect”.
Robinhood investors who indulge in day trading, or take leveraged positions by indulging in futures and options, or those who are betting on penny stocks are bound to face a catastrophe wherever they are located. These investors are bound to find out sooner or later that flipping a stock market for a quick buck won’t make them a Warren Buffett overnight. It takes decades if at all possible. Remember stock market resembles a ‘World of Oceans’ where big fish becomes bigger by eating small fish. But it does not mean that no small fish survives or grows. Yes, some small fish also survive from falling prey when either it takes all the precautions while moving around, or as a matter of luck. In stock market parlance for small investors it implies that stock market is a dangerous world to navigate without being realistic and very cautious. Investing in stock market can make a retail investor to earn more returns provided he or she is able to notice the ‘Red Flags’ flying high in the landscape of stock markets. These flags single caution; not to resort to day-trading, or take leveraged positions, and also keep away from penny stocks. Investing in penny stocks is extremely risky, it is like buying a lottery ticket, thus can makeone to win a “Jackpot or Lose Everything”. It is estimated that people have lost between Rs. 1.5 – 2 lakh crores on penny stocks in the last six years in the Indian stock market.
Final World
It is the most difficult times for stock markets world over. On the one hand, economies are under huge stress due to COVID-19 pandemic and on the other, future is quite uncertain. Besides, markets are giving some unusual signals. In spite of huge uncertainty about the economic revival, the markets are moving up. The other unusual trend is that generally when equities perform, which indeed has happened during the last quarter, gold does not perform. But this time around gold prices have also gone-up significantly. It is also that the correlation between actual fundamentals and liquidity makes no sense. So currently it is difficult to trade or invest in the market particularly for retail investors. Therefore, the message for such investors is to be extra cautious, not trying to outsmart the market. One can invest this time but with a long-term perspective through ‘Systematic Investment Plan’ in liquid companies having strong fundamentals with a caveat to strictly adhere to ‘Efficient Market Hypothesis’.
Dr. Khursheed Ahmad Butt is Professor, Department of Commerce, University of Kashmir