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How Does Robinhood Work?
By Jamela Adam MONEY RESEARCH COLLECTIVE
While thousands of businesses worldwide entered fight-or-flight mode during the COVID-19 pandemic, some companies thrived like never before. Robinhood was one of them. With quarantines and lockdowns in effect and the stock market booming, millions of people turned to investing in the stock market. In fact, according to Robinhood’s IPO SEC filings, in 2020 alone, Robinhood’s net funded accounts grew 143% from $12.5 million to $18 million. Their total revenue also grew by 245% to over $900 million.
So if you’re interested in the world of investing, Robinhood is, without a doubt, a platform to familiarize yourself with. But how does Robinhood work and how do you get started? Read on as we dive deep into how to use Robinhood to invest in your future.
What is Robinhood?
Robinhood became a household name in the fintech industry during the GameStop and Dogecoin frenzy as amateur investors piled into the market. And though it may seem like Robinhood popped out of nowhere, this brokerage has actually been around for some time.
Founded in 2013 by Vladimir Tenev and Baiju Bhatt, Robinhood’s stated mission is to democratize finance for all. Tenev and Bhatt followed through on this promise by lowering the barrier to entry for stock investing. They offered free account setups and 100% commission-free trades. As of today, Robinhood still operates on a freemium model — providing a free basic service and charging for premium features, and developing other revenue streams that we’ll touch on later in this article.
Robinhood has another impressive perk worth mentioning: fractional share trading. Fractional shares are simply smaller units of a single share. So if a stock is trading at $100 and you only have $10 to invest, with Robinhood you can purchase 10% of a share or 0.1 shares. This allows investors to get started in the market with less money needed to purchase a whole share of stock. Besides stocks, Robinhood also offers options and cryptocurrency trading. To keep up with the recent cryptocurrency hype, the company even launched a crypto gifting feature that allows users to send crypto to their family and friends.
Robinhood gained a lot of traction in recent years thanks in part to its mobile-first design. The interface is clean and simple, making it easy to place trades on the go — perfect for millennial or Gen-Z investors who prefer to trade on their phones.
Another way Robinhood has kept ahead of the curve is by offering a commission-free cryptocurrency exchange on the same platform where it offers stocks, ETFs, and options. Though only about a dozen cryptocurrencies are currently tradable on Robinhood, they include some of the big dogs such as Bitcoin, Ethereum, Solana, Dogecoin, and Shiba Inu. The platform also offers a dynamic real-time graph of the market price of each coin that refreshes automatically every 15 seconds. It may not yet be one of the best crypto exchanges, but given the pace of Robinhood’s innovation and expansion, it wouldn’t be a surprise if crypto became a major part of its business in the near future.
How does Robinhood make money?
If Robinhood democratizes finance for all by providing commission-free trading, how does it generate enough revenue to keep the business running? It turns out that Robinhood sustains itself with multiple revenue streams — with the four listed below bringing in the majority of the cash.
Robinhood Gold
Launched in September 2016, Robinhood Gold is a subscription plan that provides investors with various premium-tier tools. For a monthly fee of $5, Robinhood Gold subscribers can receive access to larger instant deposit amounts, Level II market data from NASDAQ, professional research information from Morningstar, and margin borrowing. And if you aren’t sure whether this premium subscription is the right fit for you, you can try out the first 30 days for free. It’s worth noting that the margin trading feature is optional, and not all investors are eligible to trade on margin. But if you qualify for margin trading, you’re responsible for paying a yearly interest rate of 4.25% on any borrowed funds over $1,000.
All in all, for anyone who’s an active trader — or plans to be — the extensive features of Robinhood Gold make it a viable and affordable choice.
Cash management
Another recently launched feature that helps diversify Robinhood’s income stream is Cash Management. This feature allows Robinhood users to park their uninvested cash in an account where it accrues interest and can be accessed with a Robinhood debit card. The company moves customers’ uninvested cash into FDIC-insured partner banks. These banks then pay Robinhood a fee and also allow Robinhood to take a small cut of the interchange fees from the debit card transactions.
Securities lending
In early 2022, Robinhood launched a new stock lending program that allows Robinhood customers to earn money on stocks they own. When users enable this feature, the company lends its customers’ shares to another party. These can be financial institutions seeking to cover deficits, facilitate trade settlements, or execute short sales. The borrower then pays Robinhood interest on the loan, and a portion of that revenue is passed onto Robinhood users.
Rebates from market makers
Robinhood also generates a significant portion of its revenue from payments for order flow. This practice, which is used by other brokers as well, involves routing customer orders to market makers in exchange for rebates. While it isn’t necessarily illegal or unethical, it has come under scrutiny in recent years due to concerns that it may lead to higher costs for customers. In light of these concerns, Robinhood has disclosed its policy on payments for order flow. It has also taken steps to ensure that all customers are aware of the potential impact on their trading costs.
How to buy and sell stocks on Robinhood
If you’re overwhelmed by the idea of getting started with Robinhood, don’t worry. It’s not as complicated as it seems. Here’s a step-by-step guide on how to buy and sell stocks on the platform:
- Create an account: After you’ve downloaded the Robinhood investing app on your mobile device or have accessed the web-based interface, you can create an account with Robinhood. But here are some basic requirements you need to meet first:
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- Be 18 years or older
- Have a valid Social Security Number
- Have a legal U.S. residential address
- Be a citizen or permanent resident of the United States, or hold a valid U.S. visa
- Deposit funds: Once your account is successfully set up, you’ll need to deposit funds before you can start trading. To do so, link your bank account to Robinhood and transfer funds directly. If you prefer to fund your account with your paycheck, you can also set up a direct deposit on your payroll provider’s site through the Robinhood app.
Keep in mind that you can only make 5 deposits into your brokerage account per business day, and the total daily amount must not exceed $50,000.
- Choose a stock: Once you have the funds available in your account, you can start looking at stocks to buy. One of the many perks of Robinhood is that it partners with NASDAQ to provide customers with real-time last-sale prices of stock without charge. This allows you to stay up-to-date with market data and make the most informed investment decisions. The company also publishes after-hours trading data.
- Place an order: Robinhood allows you to trade in dollars or in shares. When you’re ready to purchase a certain stock, navigate to the stock’s detail page, select “invest in dollars,” and enter the dollar amount you’d like to purchase. If you’d prefer to order in shares instead, select “invest in shares.” Once you’ve reviewed your order and made sure that all the information is correct, you can proceed to submit the order.
- Sell your stock:
The process of selling a stock is quite similar to the process of purchasing it. First, head to the stock’s detail page and click on the “Sell” button on the side of the screen. You can choose to either sell the stock in dollars or in shares. And once you’ve entered a value, click on “Review Order” to make sure there weren’t any typos or mistakes. Then, when you’re ready to sell, click on “Submit Order.”
Is Robinhood safe?
Robinhood’s straightforward and easy-to-use platform has demystified trading for many new investors. But even though Robinhood has attracted millions of beginners who are eager to start their investing journey, some are still hesitant about the platform and wonder if it’s too good to be true. If you’re one of those people, here are two facts that should give you some reassurance.
First, Robinhood is a member of the Financial Industry Regulatory Authority (FINRA), a trade organization that establishes ethical rules for investment brokers, examines member firms for compliance with those standards, promotes transparency, and educates investors. FINRA is a self-regulatory organization authorized by the federal government. As of today, more than 624,000 brokers in the United States are voluntarily registered with FINRA.
Second, like other brokerages, Robinhood is regulated by the Securities & Exchange Commission (SEC), the government agency responsible for regulating the securities markets in the United States. The SEC requires brokerages to disclose certain information to potential investors and also imposes restrictions on how brokerages can operate. Here’s an example: the SEC requires that all trades be executed at fair prices, and prohibits brokerages from engaging in insider trading. By ensuring that brokerages operate transparently, the SEC protects investors from fraud and abuse.
Nevertheless, even though Robinhood is regulated by the SEC and monitored by FINRA, the company can still make mistakes and experience glitches. In 2021, Robinhood was ordered by FINRA to pay a record fine of $70 million over system outages and misleading information. These problems steered Robinhood users into risky investments and caused substantial losses that could’ve been prevented.
The takeaway here is that even though brokerages like Robinhood are supposed to comply with regulations, they might not always do so, whether by accident or design. So make sure to err on the side of caution when it comes to participating in the securities market. And don’t forget to perform your due diligence before taking the plunge into a new investment opportunity.
Conclusion
If you’re looking for an investment app, consider giving Robinhood a try. The app is designed for beginner and amateur investors who want to get started with investing without paying high fees. Plus, with its fractional share trading feature, you can invest in expensive stocks without having to come up with a large sum of money upfront. This also allows you to spread your money across multiple companies and sectors, rather than putting all your eggs in one basket.
Once you’re ready to get started, sign up with Robinhood and receive a free stock worth between $5 and $20. And if you ever have any questions about the trading platform, you can contact Robinhood’s 24/7 customer service.
