I was wondering why the startup Robin Hood can offer free stock trading, while other online stock brokers ask commissions. How is it possible that this is the first initiative that offers this kind of free stock trading? Do you think that this kind of trading has a future? (trading without fees)
It isn't the first initiative (see link below) and maybe this one will stick around. Time will be a good test.
Here is an article on it.... http://www.investopedia.com/articles/active-trading/020515/how-robinhood-makes-money.asp
They plan to make money off unused balances - so they hope to get the masses signed up using the 0$ fees. Also, no type of advanced trading, just limit and market orders.
Think of it this way - even if someone puts in 100$ and buys a stock at 88$...that 12$ sits there. Multiply that by say....200,000 accounts and then do a basic 3% return on that.
Also, they plan for margin accounts in the future.
Time will tell.... sort of like I use Acorn right now (but it charges a fee to invest - a slightly higher than normal one). I signed up for fun and am just letting it ride.
All discount brokers offer a commission structure that is based on the average kind of order that their target audience will make. Different brokers advertise to different target audiences.
They could all have a lot lower commissions than they do.
The maximum commission price for the order ticket is set at $99 by the industry securities regulators. When discount brokers came along and started offering $2 - $9.99 trades, it was simply because these new companies could be competitive in a place where incumbents were overcharging.
The same exists with Robinhood. The market landscape and costs have changed over the last decade with regulation NMS, and other brokerage firms never needed to update drastically because they could continue making a lot on commissions with nobody questioning it.
The conclusion being that other brokers can also charge a lot less, despite their other overhead costs.
Robinhood, like other brokerage firms (and anyone else trading directly with the exchanges), are paid by the exchanges for adding liquidity. Not only are many trades placed with no commission for the broker, they actually earn money for placing the trade. If Robinhood was doing you any favors, they would be paying you. But nobody questions free commissions so they don't.
Robinhood, like other brokerage firms, sells your trading data to the highest bidder. This is called "payment for order flow", these subscribers see your order on the internet in route to the exhange, and before your order gets to the exchange, the subscriber sends a different order to the exchange so they either get filled before you do (analogous to front running, but different enough to not be illegal) or they alter the price of the thing you wanted to buy or sell so that you have to get a worse price. These subscribers have faster computers and faster internet access than other market participants, so are able to do this so quickly.
They are also burning a lot of venture capital like all startups. You shouldn't place too much faith in the idea they are making [enough] money.
They also have plans to earn interest off of balances in a variety of ways and offer more options at a price (like margin accounts).
They make money off you by increasing the spread you buy and sell your stocks through them.
So for example, if the normal spread for a stock was $10.00 for a buy and $10.02 for a sell, they might have a spread of $9.98 for the buy and $10.02 for the sell. So for an order of 1000 shares (approx. $10000) they would make $0.02 per share which would equal $20.00.