Have you ever wondered how online trading platforms make money if your trading is supposedly “free?” Despite not charging customers to trade, Robinhood made $180 million from its customer’s trades in the second quarter of 2020 — about double that from the prior quarter, according to a recent Securities and Exchange Commission regulatory filing

What Is Payment For Order Flow?

Like the other online brokerage firms such as Schwab, E-Trade, and TD Ameritrade, Robinhood makes its money on what is called “payment for order flow” instead of traditional commissions. That way, it can advertise to its potential customers the advantage of “free” trading.  This business model relies on payment for order flow which is essentially a back-end payment paid to Robinhood by a third party that executes the trade. According to the SEC, payment for order flow is when a market maker (a firm that buys and sells securities on a regular and continuous basis at a publicly quoted price) agrees to pay your brokerage firm for routing your order to them. Payment for order flow is one of the ways your brokerage firm can make money from executing your trade.   

With an online firm such as Robinhood that executes millions of trades, this payment for order flow is quite a profitable business model. According to its own public filings, Robinhood made 271 million dollars from this type of payment in the first half of 2020. Robinhood did not always properly disclose this fact to its customers. In fact,  according to the regulators, although more than half of Robinhood’s profits came from payment for order flow in 2018, until October 2018, the section of Robinhood’s website called “How We Make Money” disclosed only that it profits from margin trading services and interest earned on customers’ deposits. It failed to mention that it also makes money from selling customers’ orders for stock and options trades to high-speed trading firms, known as payment for order flow. As reported by the Wall Street Journal, Robinhood is facing a civil fraud investigation over this earlier failure to fully disclose its practice of selling client orders to high-speed trading firms. 

Robinhood has Made Millions on Its Client’s Frequent Trading 

The majority of Robinhood’s recent profits are from the trading of options which are generally held for a shorter term, and traded more frequently, than stocks. How do options trading help Robinhood and other online firms make more money? This is because payments for options orders are significantly higher. Some have criticized Robinhood for encouraging inexperienced investors to trade options, and research has shown that options trading is generally detrimental to individual investors. Robinhood reported that during the pandemic, it saw deposits into its accounts that were equal to or multiples of the stimulus checks from the Trump administration’s $2.2 trillion CARES Act and that young traders see market downturns as “buying opportunities.”

Robinhood seems to have perfected a business model where it reaps more money than its online competitors in payment for orders. As reported in a study of SEC filings done by Piper Sandler (below), Robinhood made the most money per 100 shares in payment for order flow this year.

robinhood trading

Robinhood’s Platform Encourages Frequent Trading

Perhaps this is because, more than at any of its retail competitors, Robinhood’s users trade the riskiest products and at the fastest pace, according to an analysis of new filings from nine brokerage firms by the research firm Alphacution for The New York Times.

According to that analysis, in the first three months of 2020, Robinhood users traded nine times as many shares as E-Trade customers and 40 times as many shares as Charles Schwab customers, per dollar in the average customer account during that time. That same analysis found that Robinhood customers also bought and sold 88 times as many risky options contracts as Schwab customers, relative to the average account size.

Robinhood’s platform encourages more trading because it is paid more if its customers trade more often. Because its customers are mostly young and inexperienced traders, this can often lead to disaster. The New York Times reports that Robinhood’s success appears to have been built on “a Silicon Valley playbook of behavioral nudges and push notifications, which has drawn inexperienced investors into the riskiest trading, according to an analysis of industry data and legal filings, as well as interviews with nine current and former Robinhood employees and more than a dozen customers.

But options trading is not suitable for every investor and it can cause catastrophic losses in short time periods. 

Robinhood’s Customer Service Access is Reportedly Limited

Disturbingly, inexperienced investors with a problem in their Robinhood account may find that there is no live person to call and speak with where there are issues with their account or if they have an urgent question or a technology glitch. As is common of Silicon Valley businesses, accessibility is relying on technology, not human beings. The app provides no phone number for customer service. According to Bloomberg, it was offered years ago, but the number was removed.

Academic research has shown that the more active individual investors trade, the worse they tend to perform. However, those studies were done before the “free” trading era. But as costs have fallen, markets have gotten faster and more competitive. Anyone trading from a phone app is trying to outwit increasingly sophisticated pros on the other side of the bet and, as Bloomberg notes, it’s still not an even matchup. And, if you cannot contact a human being when you have an urgent time-sensitive issue,  trading problem, or a technical glitch you may be further harmed.



If you or a loved one have suffered investment losses as a result of online investment in options or any other type of investment fraud or broker negligence, contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States. Contact us by filling out our online contact form, or calling 888-768-2499 or 305-349-2336.