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NPR. Everyone station in Cardiff here, this is indicated from Planet Money buying and selling stocks on the smartphone app Robinhood has become incredibly popular this year, especially since the covid pandemic started. And there are a few possible reasons why.
First of all, everybody's home and has lots of spare time. That's got to be part of it.
Maybe also, of course, you know, maybe people had a little extra money to invest because so many restaurants and shops were closed. Also, maybe people sense an opportunity to buy stocks cheap when the stock market collapsed in the first month of the pandemic.
Whatever the reason, Robinhood announced recently that the amount of money it makes from people trading on its app doubled in the second quarter of the year to one hundred and eighty million dollars. It's a lot of trades.
Yeah, and Robinhood has also become kind of famous for the clever ways that it entices people to use its app to buy and sell stocks. So digital confetti or some other animation might fall across the screen when you first deposit money into the app.
We are simple creatures to take away from that. Hard to get us in there. Yeah.
And Robin Hood also offers free stocks to people who sign up for a trial run into people who convince others to sign up.
James McComb is twenty five lives in Long Island in New York. He is a big Robin Hood user. And there are several things he likes about Robin Hood's design and how simple and seamless it is to keep track of what's happening for any company he is interested in.
That's a great app for easy information, almost like a news feed, but for stocks.
Plus, the Robin Hood app shows a ranking of the most popular stocks that other Robin Hood traders have been buying, which, you know, might convince new traders to join the party. James himself invested money in Uber stock partly because it was number one on Robin Hood's popularity ranking.
I can kind of get a little bit of a sense of confidence, like, OK, people believe in this company because it's literally number one on the list.
Currently, James, is what is known as a retail trader, which is basically anyone who buys and sells stocks for their own personal account, not a professional investor who manages other people's money. And this year it is retail traders like James who have really thrown themselves into the stock market.
And because the U.S. stock market has gone up in recent months, even hitting a new record high last week, a lot of these retail traders have made quite a bit of money lately.
But are there maybe some reasons to worry that so many retail traders have started buying and selling stocks using apps like Robinhood?
I would say two parts worried, one part happy. This is Colin Camerer.
He's a behavioral economist at Caltech and he has studied the ways that people invest in the stock market.
Cohen says one good thing about Robinhood is that by making it so easy to start buying stocks, it might get people invested in the stock market who otherwise might never have bothered at all. And this can also help people learn more about how specific companies operate and to better understand how the economy works, especially these days the digital age, when it's so easy to find useful information.
It was a lot of stuff under the hood in the economy, and it would be good if people knew more about that. And they may learn some by just buying and selling some shares of a particular stock and learning about what boards of directors do and, you know, how companies actually operate.
But Collins said he was only one part happy and two parts worried about Robin Hood's popularity with retail traders. So here's why he's worried. If there is one conclusion that the research about financial markets keeps arriving yet again and again, it's that individual traders who actively try to pick specific stocks, buying the stocks they think will go up, selling the stocks they think will go down are very likely to underperform the overall stock market.
And this doesn't just apply to retail traders. It also applies to professional money managers. Over the last five years, 82 percent of mutual funds that tried to pick stocks underperformed the overall stock market, which means that most people are just better off investing in what they call an index fund that just tracks the performance of the stock market, goes up and down with it over time.
And Collins says retail traders are also vulnerable to psychological biases that lead them to make bad decisions when they invest, especially if they don't understand the risks that they're taking.
If you're buying somebody selling and you have to be confident that you're buying from someone who knows less than you about the future of the stock. So one of the elements in in retail trading is overconfidence. You know, everybody thinks they're above average.
Also, confetti and confetti just sucks you right in. Plus, people fall victim to what's known as the disposition effect, which makes people sell stocks that have gone up a little too soon, missing out on making even more money.
People have a tendency to sell the stocks that went up. And we think it's because there's a special kind of value called realization utility from actually locking in your gain and clicking and like seeing it in your bank account, you know, from your portfolio. Numbers on a screen into your bank account or something like one, so people saw winners too soon and similarly they tend to hang on to losers, typically in a kind of blind faith that it's going to bounce back.
Making these kinds of trading mistakes is something that happens when people are actively and frequently buying and selling stocks. And of course, the Robinhood app is designed to get people to do just that. And Robinho, its business model, actually depends on it. More on this after a quick break. Support for NPR and the following message come from you studio, you studio securely distributes corporate audio and video content to employees. Use your studio to manage your company's public or private podcast to remotely share meetings and town halls and improve employee communication.
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OK, so here is how Robin Hood makes money. Let's say I have 10 shares of Jamba Juice and I want to sell them.
I would place an order in the Robinhood app. Robinhood would then send that order to another company company called a market maker. That market maker would buy those 10 shares of Jamba Juice stock that I'm selling and then it would try to sell those shares to someone else for more money than they paid me. And then it would keep the difference.
Yeah, the market makers kind of like a bookie. It just tries to match people who are buying with people who are selling. And it keeps the difference. And in exchange for the privilege of receiving those orders, the market maker pays Robinhood a fee. And the more orders it receives, the more it pays to Robin Hood.
So you can see why Robin Hood has a big financial incentive to get people to buy and sell stocks frequently and why it's designed, it's apt to encourage that outcome confetti at all, even though that is probably not the best strategy for people to make money over time.
And this is why behavioral economist Colin Camerer says that people should not have more than about 10 percent of their overall money devoted to picking stocks on Robin Hood and other apps like it gets a bit like gambling.
So casinos know that there are people who have a problem with pathological gambling. And every casino, if you go to Las Vegas and you sit and have a free drink or you sit at the bar will have a matchbook that says no problem gambling, call this hotline. But they're not really in the business of keeping people from losing money.
They're in the opposite business, not to mention all of the lights and sirens and sound effects and free drinks and real real life confetti. Real life confetti. That's that's true.
James McCombe are Robin Hood from Long Island, says that he totally gets this.
When he first started trading on Robin Hood four years ago, he lost 80 percent of the money that he had invested in just a few months over the past year, though, he says he has almost made all of it back. Now he is just down three percent, but still a loss.
Yes, small loss. And he says he's cool with that. But you know what? Over the same four years, the overall stock market actually went up more than 60 percent.
So he would have made more money if he had just invested in an index fund.
Yeah, a lot more money. And in fact, James actually says that he is much more careful with the money that he puts towards retirement. He invests that money in safer, diversified funds.
I haven't ever withdrawals any money from Robin Hood, so I don't actually know what the end goal for that money is. It's just something that I keep in there. And I you know, maybe it'll end up being a bonus to my retirement. But I, I just don't I don't see it as that. So I'm not, like, relying on that for my future.
I know exactly what the goal of that money is. What's that? It's confetti, right? It's confetti, confetti by the party buying a little moment of. Robin Hood spokesperson sent us a comment saying that Robin Hood has invested in resources to help customers learn about the markets and make informed decisions, and that the app is designed for customers to learn and to invest responsibly. This episode of the indicator was produced by Jamila Huxtable and Nick Fountain, it was fact checked by Brittany Kronin.
The indicator is edited by Paddy Hirsch and it is a production of NPR.
I'm Guy Raz and on NPR's How I Built This, How a simple splash of color accidentally launched Sandy Chilliwack into a 40 year career as a designer, entrepreneur and creator of the now famous Chilliwack placemat. Subscribe or listen now.