Robinhood Markets Inc. has been at the forefront of the democratization of finance, which is the idea that an average Joe can play in the stock market alongside the professionals. And back in January, they did, nuking a bunch of hedge funds betting against GameStop Corp. in one of the greatest short squeezes of all time. Hollywood is full of average Joe underdog stories, but is it true in real life? Not, at least, in the markets, where retail trading of “meme stocks” is, on balance, just a massive transfer of wealth from the unsophisticated to the sophisticated.
At issue is the longstanding practice in the equity markets known as payment for order flow. Brokerages don’t actually execute orders to buy and sell stocks anymore; they send them to market-making firms for execution in exchange for a small payment. This allows brokers to offer zero commission trades. Market-making firms like this arrangement, especially when it involves orders for retail investors because they are typically wrong and are profitable to trade against. So market-makers will pay brokers for the privilege of receiving these orders, on the idea that even though they are small individually, in the aggregate they are profitable. Robinhood earned about 75% of its $958.8 million in revenue from payment for order flow in 2020.