This week has been some ride and has brought up questions about whether the stock market really is a free market.
Pretty much every retail app has halted or limited buying of specific stocks for retail investors. To make people even madder, it was limited to where you could only sell your stock. There were no such limitations of the large hedge funds. Read this article on Yahoo for more specifics but I’ll give you the basics.
On Thursday, Jan. 28, Robinhood ignited bipartisan fury with its decision to restrict users’ ability to buy calls or shares in GameStop (GME), the stock at the heart of an epic short squeeze.
The perception was that Robinhood cut off trading access to its retail customers, who were long GME, in order to placate its hedge fund paymasters, who are short GME and would prefer the price to fall.
The thinking was that, by preventing retail investors from buying GME, Robinhood was doing the bidding of Citadel, a giant hedge fund with a market-making operation and a high-frequency trading arm attached.
Citadel was also a known backer of Melvin Capital, the $12.5 billion hedge fund that received a $2.75 billion emergency cash infusion to stay afloat, after losing heavily on GME and other shorts.
Because commission revenues are zero, Robinhood makes the bulk of its profits from something called “payment for order flow,” which involves giving firms like Citadel the chance to take the other side of retail customers’ trades (a consistently profitable thing to do).
It seems like an open-and-shut case in respect to the fact that, even though GameStop buyers are trying to play a game with the market, hedge funds have been playing those same types of games for decades; so why should the playing field be tilted in favor of the hedge funds who were short?
While the deep well of anger was understandable, and legitimate, it entirely missed the real story.
Despite the way things appeared — and the way they were interpreted — Robinhood did not suspend the right to buy GME shares (and a handful of other names) at the request of Citadel.
Robinhood took the actions it did — and another popular firm, Interactive Brokers, did the same — out of fear that the whole system would break, and that Robinhood itself could be wiped out. Robinhood was afraid the GameStop situation would destroy not just the hedge fund shorts, but Robinhood itself.
That is why Robinhood restricted trading, and that is why Robinhood built a billion-dollar firewall of added capital buffer before allowing GME buys to resume.
Now, one may ask, why did Robinhood let an avalanche of bad press fall directly on its head?
Why would Robinhood, as a firm, let all of Washington D.C. and the whole world believe they had done an awful thing, in helping Citadel at the expense of their investors, instead of explaining what really happened?
Because if Robinhood explained what really happened, all hell would have broken loose. And it still might.
Stay tuned as we dive deeper and figure out if we still have a free market or not.
Credit to TradeSmith for the content of this post.
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