Is Robinhood Dangerous?

The stories that we heard and watched so many time how Robin Hood swooped down from a tree and robbed from the rich and gave to the poor were classic in itself. Hence, we all automatically infer that Robin Hood was the good guy.

However, today we are not discussing the person from the folklore but the application (app) that was recently put under the spotlight for causing a 20 years old man to commit suicide after finding out that he lost $730,000 betting on options. It was sad to say the least and really unfortunate to have such a tragedy inflict on a family. However, I’m not here to discuss what went wrong with app but to argue if Robinhood is dangerous?

Before I continue I want to state my position. I don’t think the app is dangerous, but I think the tragedy could be avoided if there is failsafe built on the app that would flag any anomalies in trading. I am neither a programmer or developer so I am not in the position determine if there is any artificial intelligence or models built in that would capture these anomalies. News outlet claim that there was a system error in the balance of the 20-year-old which ultimately led to the death of the trader. Could this be a “freak” error that could not have been thought of by the app developers?

If you read my earlier posts, I pointed out that trading was originally reserved for the riches. The revolution started when Robinhood allowed the mass to trade for free beginning in 2013. Since then, there are a lot more companies are using the same business model. Even the large and established investment companies have started to offer free trading to their customers. Did Robinhood started something that increase trading risks, particularly for the milenials?

Fine Print in Trading – Trading in financial markets is risky. The inherent risk is high and anyone who is involved in trading should understand the risk. Before anyone who wants to begin trading, he or she should know this and should set a risk tolerance the he or she is willing to take. Trading is not FDIC insured and this is clearly stated in the agreement before an account could be opened. Additionally, all agreements also state the risks involved in trading.

Some brokerage firms also try to protect investors by assess their portfolios to ensure the risks are reduced. For example, I was prevented from buying stocks in my Citigroup brokerage account because I have 100% of my portfolio in equity stocks. To reduce the risk, I was advised to diversify my portfolio.

Good Knowledge in Trading – Trading in financial markets is different from purchasing a product in Amazon. You look at the product to see if it meets your needs. Then you find out if it is reliable by reading the reviews. Trading in financial markets require not only the stocks itself you need to understand how the financial instruments. I personally am not well versed in all the different instruments available so I am not going to attempt to explain each one of them.

Equity trading is perhaps the easiest – buy low and sell high to make the profit margin. However, for someone who is new to buying stocks, you do need do some research on the stocks you are buying. Reading the market news is perhaps the easiest way to do research. Options trading is perhaps the most difficult to understand. And option is an contract that allows an investor to buy or sell an underlying instrument like a security, ETF or even index at a predetermined price over a certain period of time.  A trader will need to have a good understanding how it works, what to bet on, and has a high level of risk tolerance. if you place your “bet” right the profit margin could be great and the opposite is true. The 20-year-old trader may not had understood this and bought options based on someone’s suggestion.

Don’t Be Greedy and Understand the Risk – The old adage that there is no free lunch is very true in the trading business. Don’t expect to double what you invested in a short period of time. Time commitment and upfront asset are required. Once you started the investment you are required to keep investing for a long period and hopefully the amount you invested will continue to grow over time. Being greedy and hoping a payout not only it is impossible, the risk is extremely high. As an example, a trader could invest in a “hot” stock that has recently been increasing in price due to an unusual market conditions. However, once the real news come out it could unravel really fast and there is a high possibility of losing all the money you invested. I had the unfortunate opportunity to invest in China’s Starbucks called Luckin Coffee earlier this year. After reading one of the articles in a magazine how the company became a rising star in the Nasdaq stock exchange. The stock went from $19 to $50 in just a year. When news came out that the company fraudulent boost its earnings, the stock price quickly dropped to $4 and was subsequently de-listed from Nasdaq. I lost lost to $900 after selling the stock for $2.50.

Know One’s Limit / Know When to Back Out – Anyone who is interested in investing in stocks must have a good understanding on his or her current financial situation first. If someone who carries a large debt, investing may not be a priority. If the person does not have extra liquid assets committing the asset in stocks is not advisable. A large portion of my investment is in 401k retirement plan. I only invested about 20% of my liquid asset in the open market and of those 70% are in equity (or individual stocks). I tried to keep my risk low but at the same time want to grow my asset at a steady pace. I continue to read the business news and stock market highlights to understand the market conditions. If for any reason that there is adverse market conditions I will only lose 20% of my asset.

What had happened to the 20-year-old was really unfortunate. Robinhood could be the cause but in no way directly responsible for the tragedy. Legally there is a clause in the agreement noted that there is a risk in all types of investment. Without a good understanding of how the financial markets work will only increase the risk when it comes to investing.

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