Robinhood, the Efficient Markets Hypothesis and the Gamification of Investing

30 years ago, investing was a serious business.  (Actually, it was no more serious than it is today, just harder to access.)  Opening a brokerage account required minimum balances that were beyond the reach of the average twelve year old, placing orders was manual requiring multiple telephone calls, settlement was T+5 for equities and commission rates were high and non-negotiable except to the most well-heeled investors.  These days, technology has wiped out several layers of human intervention to the point that an individual school girl – lets call her Marion – can buy a fraction of a share in her favourite Chinese Dance-Tok company using her mobile phone during play-lunch.  Robinhood is the market leader in this astonishing technological advance allowing Marion to spend $5 on Dance-Tok shares without any trading fees whatsoever.

Robinhood has made Marion’s investment experience into something resembling a mobile phone game.  A successful trade is trumpeted with a congratulatory rift, confetti streams across the screen and happy faces report profits.  Robinhood is also accused as one of the major brokers involved in the Gamestop ‘rocket event’ where a group of like-minded investors began purchasing the company’s stock at higher and higher prices for FUN.  Gamestop was ripe for a short-squeeze on account of some high profile hedge funds being negative on the stock.  As the stock rose from $8 to $50 the shorts were forced to cover and onward went the shareprice to $460 at its height.  Unlike the traditional approach to squeezing shorts where a small group buy the majority of the outstanding float of a stock, this was a ‘crowdfunded’ voluntary coordinated effort that drove Gamestop’s price far beyond its arbitrageable limits without attracting arbitrage.

The Gamestop – rocket has largely come back to earth and the regulatory post-mortems have begun.  Robinhood’s gamification of the investing experience is directly in the sights of the SEC, congressional lawmakers and various agencies.  Is an app that opens up the investment markets to the Marion’s of society such a bad thing and should it be allowed to be ‘FUN’?

The Efficient Markets Hypothesis (EMH) has a lot to say about this issue.  In its simplest form, the EMH posits that the current price of a security is an unbiased predictor of the range of future outcomes for the stock.  Another way to think about it is that the price of the stock reflects all publicly available information so that there can be no advantage to any individual investor from studying what is already known in the market.  This is great news for Marion and her friends who decide to purchase IBM, JPMorgan or Dance-Tok during play lunch.  The EMH promises that her investing experience will be just as safe as any other investor in the markets – she is on a level playing field with all other investors.  The EMH also posits that the expected return on a stock must be positive in order to induce investors to hold it (there are exceptions to this rule) so that Marion’s investing game actually has an expectation of making money whereas most other games require in-app purchases which are costly to keep playing.  Robinhood therefore finds a lot of support for its app from the EMH.

The EMH, on the other hand, has a tougher time defending the cohort driving Gamestop’s rocket experience.  $460 is a long way from a fair-value range for the stock of $5 to $10 as some analysts had posited.  As the stock price rose many times short sellers must have been tempted to sell.  However, this risked being slammed by the cohort of rocketeers that simply bid up the stock at every opportunity.  In its strictest form, the EMH requires that a self-financing portfolio should not have a positive return.  This is the rule against a money-machine that costs nothing to operate but spits out money at various points in time with no risk of a negative outcome.  On this logic Gamestop’s rocket did not violate the EMH since there was always a chance that some rocketeer would push the stock price higher for FUN thereby causing a loss to short sellers.  At some point, of course, the rocketeers run out of money and the FUN stops.

I doubt that stopping the bells, whistles and confetti on Robinhood will make the app any less appealing or relevant to the new breed of investor.  Forcing Robinhood to charge a fee per trade, on the other hand, will kill the rocketeers but also force the Marion’s of society to seek their thrills in Roblox.  This would be such a shame

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