Robinhood’s stock has sent investors and short-term traders into a frenzy less than one week after its IPO.
Trading under the ticker symbol HOOD, the stock went public on July 29 at the bottom range of Robinhood’s initial price projection. The stock then fell lower, hitting $33.53 the next morning.
But along came a surge of buyers, and the stock price more than doubled, from $35.83 to $77.03 in less than 48 hours, followed by a considerable pullback. Many of those traders took on options contracts.
What is causing such wild price action? And is Robinhood just another dangerous meme stock like GameStop that will leave some buyers holding big losses?
What Is Robinhood, and Why Is It Controversial?
Digital natives mostly have embraced the often controversial online trading platform, leading to explosive growth. Robinhood boasted about 18 million users and $80 billion as of early July, according to CNBC — up from 7.2 million users in March 2020.
It first made a name for itself by competing with the so-called “discount brokers” via zero-commission stock trades. But Robinhood’s seamless, easy-to-use app, which I reviewed earlier this year, has drawn criticism for attracting people who treat the stock market like a casino.
“You’ve got inexperienced people without a lot of capital that are engaging in trading activity that can be dangerous to their financial well-being,” money expert Clark Howard said. “You have people who are trading like it’s gambling. To them, it’s like they’re in a giant electronic casino rather than investing in stocks as a long-term financial security.”
Robinhood has had several issues with its technology crashing during high-volume days. Also, it accepts Payment for Order Flow (PFOF) as a main revenue source, a controversial practice. And the company initially did little to warn or educate its relatively inexperienced user base on the dangers of options trading and trading with leverage.
What’s Happening With Robinhood’s Stock Price Post-IPO?
Very little changed in terms of Robinhood’s valuation from the day of its IPO to its huge stock price surge less than one week later.
That has spawned a number of headlines calling Robinhood a “meme stock” and comparing it to GameStop. Despite some of the comparisons, there are some major differences, in my opinion.
The surge in Robinhood’s stock price is notable, frothy and probably not related to a material change in the company’s valuation.
Unlike Robinhood, GameStop was a seemingly dying company: The market for used console video games has mostly moved online. Yet GameStop’s stock price surged about 1,500% in January in one of the most remarkable short squeezes of all time. Leveraged hedge funds had shorted more than 100% of the available stock.
A group of opportunistic, risk-taking traders congregated through the Reddit forum Wall Street Bets and started buying the stock. That triggered a short squeeze fueled by an element of “Let’s get back at the elite hedge fund people.”
Seeing so many people do well encouraged more people to pile into the trade. Some who bought near or at the top lost significant money. In some cases, those traders lost money they couldn’t afford to lose.
How Is Robinhood Potentially Different From GameStop?
Robinhood has some significant business risks. For example, if regulators crack down on PFOF, or if something adversely impacts Robinhood’s booming cryptocurrency business, the company would probably face a big challenge.
You could argue that Robinhood is, at least in some ways, more like Tesla than GameStop. It’s a tech company with a potentially lucrative future. The stock price may be trading beyond what its fundamentals say it should be today. However, it’s not crazy for an investor to think that in the future, if it continues to do well, Robinhood could dwarf most other fintech companies.
So although the stock may be giving investors whiplash within the first few weeks of release, there’s at least a logical case to be made that the stock is worth more than its initial IPO.
Should I Avoid Robinhood Stock Altogether?
If you bought Robinhood in the first few days after its IPO and held through the massive surge, you’ve done well. However, you’ve already lost a good portion of your gains if you held past the peak.
To say it another way, it’s difficult (or impossible) to always buy at the low point and sell at the high point.
Clark is adamant that it’s financially dangerous to treat trading stocks like you’re in a casino. In other words, don’t take big risks banking on wild short-term swings. He says that true investing requires at least five years — preferably a decade or more.
Clark also discourages anyone from making concentrated investments in any one stock. He recommends that you invest in a target date retirement fund through your company 401(k) or via a Roth IRA.
If you insist on building a portfolio of individual stocks, he says you should hold stock in at least 50 different companies, if not more. And you need to monitor those companies and be able to handle tax-loss harvesting and portfolio rebalancing.
In other words, if you’re seeing all the huge gains that some people made on GameStop or Robinhood and looking to do so yourself, you’re taking a major and perhaps ill-advised risk.
There’s nothing wrong with holding Robinhood stock as part of a well-diversified portfolio. That’s assuming you research the company and decide you want to invest in it for a long time.
But it’s a bad idea to take a significant portion of your investment portfolio and make a short-term, concentrated bet on any stock. That holds true no matter how fast its price is screaming upward.