Robinhood has grabbed novice investors with their offer of free trading. Unfortunately nothing is truly free in life, but it can be cheaper! Indeed, free trading made a foreign portfolio investment possible. Historically buying foreign listed shares was prohibitively expensive. Free trading has also opened up new ways of making money from markets.
Takeaways
What is free trading
The new opportunities it provides
Solutions to mitigate the risks
Free trading is not having to pay for your trades. Traditionally companies would charge both commission on each trade, as well as account fees. Although theoretically small, these would add up over time.
The explosion of financial innovation in the early part of the 21st century has changed this. Trading apps like Robinhood have made trading virtually free.
Today's trading apps make their money in different ways. Some such as Robinhood benefit from options trading. Other rely on fees generated from providing leverage to their clients. In effect free share trading is provided to entice you to then trade more complex (and profitable for the apps) instruments.
Some of these free trading apps are running at a loss and it is likely that some form of consolidation between them is possible. This should not affect traders accounts but may mean these firms are not able to invest in their platforms technology.
In turn these may mean more technical issues on volatile and busy trading days. This is often when you most want to trade! You may therefore want to hold your long-term investments in more established investment platforms.
The sheer numbers of novice traders these firms have attracted have also meant they can aggregate orders and supply deal flow to brokers. This latter is a controversial subject,
Payment for order flow is when free trading apps receive payment for routing client orders to brokers. Call it a commission paid to the free trading apps for your orders. You do not benefit directly, but theoretically you do as this allows the free trading app not to charge you.
There are question marks though. In particular whether there is a conflict of interest. Namely are trades routed to the best (cheapest) broker (beneficial for you the client) or to the broker paying the most for the trades (beneficial for the free trading app).
The SEC has looked at payment for order flow. Despite saying it will not investigate, the frequent commentary by other market participants means it is not impossible it looks at, and demands changes.
Robinhood was the free trading app which really caught people's attention. This does not mean it is the best, indeed UK investors cannot use it. Yet it's slick advertising and user friendly app meant it won the word-of-mouth battle as novices trading app of choice.
Coming in with no fees, was also a disruptive trick which garnered attention. The aim was to gain scale by signing up the most amount of new traders.
This is fantastic for the business but does it mean it is the right app for you.
A quick search of what securities you may want to trade, may result in you finding that your selected free trading app does list them.
This is because it is expensive for the platform to list every security. At times, this can be frustrating. BAE systems, the largest EU defence stock is not available on some. It would have been a good stock to trade / invest in as a result of the Ukraine war. As result before committing to a trading app, maybe sign up to a few and work out whether they offer the assets you want: Commodties, gold, cryptocurrency, Forex or shares.
Day trading is theoretically over trading. Over trading is a problem due to fees. Free trading apps' lack of fees make regular (small) trades possible. This makes day trading even more feasible.
Another reason why day trading becomes possible is due to fractional trading. This is where you buy a % of a share, but not the whole share. When, at the time of writing, one Alphabet (Google) share costs $2,900, fractional trading opens things up. $2,900 is often the total value of a novice investors account!
Therefore buying 5% of a Google share, means only spending $145. This is the beauty of fractional shares. For those who start with a demo account, it can be a good progression to start small with your 'live trading account' by only taking small positions using fractional shares.
Addiction. Once you trade successfully a few times you will often gain confidence which may lead to bad habits and mistakes. This can include checking your positions too often (and selling too early). Also, it is easy to grow your position sizes too quickly, namely taking too much risk too quickly.
Indeed you can often end up looking for trades which do not exist and lose money stupidly. Many brokers offer leverage which is very dangerous and should be avoided unless you have years of experience.
Solutions to the above involve the following. When you first trade for real, no matter how successful you are, do not increase your account for 3-6 months. During that period watch yourself - i.e. analyse how you trade. You will be surprised to see how easy it is to improve your trading through self-introspection.
Free trading is a definite step forward for traders and investors. The reasons are different, traders will enjoy the flexibility of not having to account for trading fees. Investors will appreciate the increased compounding that no fees will involve.
Having said that, no one interacting should forget the importance of price discovery. As a result, those who run different strategies may have to consider that free trading apps may complement the trading part of their strategy but not necessarily replace their existing buy and hold (investment) account.
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