New App Offers Stock Trades for $0 Commission; End of $7 to $10 Trades at E*trade and Schwab?

Many companies claim to be discount brokers. But there is no definition of the term. Charles Schwab was a pioneer in discount trading, but other online trading firms offer lower prices.

The ultimate in low-commission trading is $0 per trade, and that model is about to hit the street. "Robinhood", a new app in the works has a huge waiting list precisely because it offers trade commissions for noting.

CNN Money reportsTrading App has 340,000 Person Wait List.

The legendary archer of Sherwood Forest is taking aim at the stock market. Robinhood is a new trading app that promises users free trades and no account minimums.

That's a big departure from the $7 to $10 fees per trade that other brokers which cater to the masses like E*Trade and Charles Schwab charge. These firms offer discounts from time to time, but only if a customer has a large account or uses other services.

Plenty of people are excited about $0 commission trades on Robinhood. The app is still in beta test phase, but nearly 340,000 people have signed up on the company's website to gain early access.

The roll out process is reminiscent of the early days of Gmail, Gilt Groupe and the Mailbox app: There's an aura of exclusivity, and if you refer more friends, you move up the wait list.

Perhaps it's not a surprise that Robinhood is taking this approach since Google Ventures is one of the company's key backers, and a former Mailbox app employee is now part of Robinhood's 15-person team in Redwood City, California.

In December, the company said it was targeting "early 2014" for launch. Now they plan to open the app up to more people on the wait list in the coming weeks and have it available in app stores later in the summer.

"Rest assured when you use it, it will be unbelievably cool," Baiju Bhatt, one of the co-founders, told CNNMoney.

Robinhood was founded by former Stanford roommates Vladimir Tenev and Bhatt who worked on Wall Street after getting master's degrees in math.

Tenev and Bhatt's job on Wall Street was to build high-frequency trading (HFT) platforms for financial institutions.

"At the time, HFTs were commonly paying a tenth of a penny per trade, which enabled the business model to operate with razor thin margins," Bhatt says. "We had a head scratcher moment where we asked ourselves, 'Why do we pay $10 when we trade our personal accounts?'"

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How Does Robinhood Make Money?

CNN offered this explanation: "The company's business model is to make money on margin trading, interest on cash deposits and payment for order flow, a fancy way of saying making money by trading faster or slower than others."

Purposely trading faster or slower and stripping out the difference is not legal. With interest rates near zero, making a lot of money on cash deposits will not be easy unless the company takes some risks. E*trade nearly blew up making questionable investments.

The Robinhood website makes this more reasonable-sounding claim: "Robinhood will offer margin trading as well as API access, which will allow partnered developers to build applications in conjunction with Robinhood. Robinhood will also receive remuneration for providing trade volume in certain markets. In the future, we plan to offer premium services for active investors."

The Catch?

I don't see one. But don't expect service at Robinhood to be the same as service at Schwab or Merrill Lynch. If you need hand-holding, advice, or insist on paper-mailed statements, you may be better off elsewhere.

Those who trade frequently will be among those who benefit the most. And ultimately, this will cost Schwab, E*Trade, Scottrade and others some business. In response, commissions will drop everywhere, even if not to zero. Increased competition always leads to lower costs. And that is a good thing.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com