How Do Free Trading Apps Make Money – Robinhood, Webull & WealthSimple
Trading apps have made investing easier for the Millennial and Gen Z population. The apps are accessible and built to make investing more attractive. Interestingly, most of them don’t charge any fees for opening accounts. So, how do they make money?
Most trading apps make money through all or some of the following: payment for order flow (PFOF), margin lending, short selling fees, interest on client funds not invested, or currency exchange fees. Most of the popular trading apps generate revenues from a combination of these sources.
The rest of the article will look at three of the popular trading apps and how they make money with the methods mentioned above.
How Robinhood Trading App Makes Money
Robinhood is a trading app launched in 2013. It operates a commission-free model to ensure low trading costs for the customers, offering options, stocks, cryptocurrency, and ETFs. The company has been valued at around $6bn and has saved customers more than $1 billion in commission fees.
How Does Robinhood Make Money?
Robinhood makes money through the following ways:
Interest
The company doesn’t leave investors’ idle cash in the accounts untouched. Instead, they invest some of it and collect interest. This investment doesn’t affect you as a customer in any way as the funds are always available for you to use without any limitations.
Special Trading Service Fees
Robinhood charges for a few other services, such as live broker trading by phone, which costs $10 per trade. Some foreign stock transactions can also cost around $35-$50. These fees can add up if you regularly use these services, but the bulk of their customer base won’t use these services.
Premium Account and Margin Lending Fees
Robinhood offers a premium account known as Gold which gives investors up to $1,000 of margin, giving them access to extra trading funds in addition to their account balance. The fees for this account start at around $6 per month. The minimum portfolio value is set at $2,000, but there are different tiers. You have to pay extra fees for more margin loans, but you can borrow up to 50% of your account balance.
Payment for Order Flow and High-Frequency Trading Rebates
Robinhood makes money for routing orders to certain liquidity providers. The amount per trade will come down to a few cents, but over millions of orders, it’s a sizable chunk of the company’s profits.
According to a Wall Street Journal article, a customer buying $20,000 worth of Apple shares can net Robinhood around $5 if they route the order to Citadel Securities LLC, for example. This is more money than some other trading platforms will make from the trade, but so is the company’s allure to liquidity providers.
The bulk of the company’s payment for order flow income comes from high-frequency trading customers, which has landed them some criticism.
As of 2018, 40% of the company’s revenue came from this source, though the company has never hidden this fact. They clearly state that they send customer orders to market makers that’ll provide better prices and excellent execution. In return, the market makers pay Robinhood some rebates, which help cover the costs of providing commission-free trading to their clients.
The disclosed market makers used by the company include Two Sigma, Wolverine, Virtu, and Citadel Securities. The co-CEO Vlad Tenev mentioned in 2018 that the company earns around $0.00026 in rebates for every dollar traded from their market maker, but this arrangement wasn’t the industry standard at the time.
Some analysts say that the company’s revenue model relies too heavily on market makers, pushing the boundaries regulations-wise. A new SEC ruling can rob them of this revenue stream, making the commission-free trading promise harder to adhere to.
Webull
Founded in 2017, Webull is another trading app provider that offers commission-free trading on stock and other assets, including currencies, cryptocurrencies, ETFs, metals, and livestock. Unlike some of their competition, they also allow trading in physical items, and there are no restrictions on minimum deposits.
Webull customers also get all the tools they need to make trading decisions, including powerful charting software and technical indicators. You can trade pre-market and after-market hours, and you can also decide to trade from an IRA or brokerage account. The company has all the tools to offer excellent trading conditions to all its clients.
How Does Webull Make Money?
Webull makes money from order flow payments, subscriptions, short-seller fees, interest paid on margin, and more, as we’ll cover below:
Payment for Order Flow (PFOF)
This revenue stream is similar to what some competitors have. When you place a trade order on the Webull app, the order is routed to a market maker, which then pays the company for the deal sent their way. It’s unclear which market makers Webull is working with, so it’s hard to determine how much they earn per trade.
Market makers make their profit from the spread (difference between the bid and ask price). Seeing as some of their competition works with multiple market makers, you may be worried about execution speed. However, all the orders are executed algorithmically to handle thousands of trades per second.
Like other apps, Webull works with market makers because they provide a competitive advantage compared to the major stock exchanges like NASDAQ. Again, after the market maker deducts their profits, Webull will be left with a small fraction that’ll add up to a healthy revenue over millions of executed orders, which explains why the company has been on an aggressive drive to add more customers to the pool.
Therefore, it’s in Webull’s interest to acquire as many customers as possible.
While PFOF helps ensure the company can continue delivering commission-free trading, they also receive similar criticisms to Robinhood because the revenue model is highly at risk of regulation-related problems.
The automatic execution of trades means that there’s no transparency on orders. Also, retail investors aren’t always guaranteed the best possible execution price when selling assets, and volatility may be manipulated on low volatility assets.
Subscriptions
As we mentioned earlier, Webull focuses heavily on providing its users with advanced trading tools to simplify their work. In 2019, they partnered with NASDAQ TotalView to give traders depth-of-book data, which includes two levels:
- Level 1 data provides information on futures, forex, indices, ETFs, and equities and is available to all the customers free of charge.
- Level 2 data gives you access to the Net Order Imbalance Indicator (NOII) and access to the 30 best bids and offers on NASDAQ, among other features. Access to Level 2 data costs around $1.99 per month.
Margin Trading Interest
Margin trading lets Webull users borrow money from the company to buy stocks and other assets. The company charges interest for providing the loan, which can be around 4-7%. You can find more information on the rates on their FAQs page.
The amount you can loan depends on your existing balance, which acts as some form of down payment in the event of a default.
Short Selling Charges
Like with margin trading, Webull can also loan shares to short-selling clients, with interest charged on the loaned dollar equivalent. Short sellers believe that the price of a stock will go down over a certain period (the expiration date). Only traders with a margin account can open a short position.
If you go this route, you’ll pay interest on the value of the borrowed shares for as long as your position is open. To close the position, you have to buy the shares back at a price lower than what you borrowed the asset for in the open market and return them to the lending company.
Webull simplifies this process by acting as an intermediary that issues stock loans, making money from the interest paid. To open a short position on Webull, you need an account balance of around $2,000. The amount of interest you’ll pay will vary from day to day and will also come down to the type and number of stocks you’ve loaned from the company.
Cash Returns
Webull isn’t a bank and doesn’t work with banks like some of the competition, which means that the customer cash in the various accounts isn’t covered by FDIC insurance. However, this doesn’t mean your funds are exposed to the risk of bankruptcy as the company insures accounts through Apex Clearing House and SPIC.
Cash on balance is insured up to $900,000 while securities are protected up to $150 million. Webull then reinvests the cash held in the account into ETFs, bonds, and other assets, keeping the profits they make through these channels.
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Wealthsimple
Wealthsimple, founded in 2014, is a Canadian financial services provider that delivers a suite of online products. Their Wealthsimple Invest is perhaps the most popular, which is a robo-advisor that provides beginners and investors with investment options that match their financial goals and risk tolerance. It’s an option favored by people going for hands-off investing.
Wealthsimple Cash is another popular product from the brand, which is a hybrid savings and checking account with no fees. You can also contribute to a Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA), and other types of accounts from your Wealthsimple balance. Like others, Wealthsimple runs a commission-free account.
Sign up for Wealthsimple here and get $10 when you deposit $100 to trade!
How Does Wealthsimple Make Money?
According to the company, the bulk of their revenue comes from the 1.5% currency exchange fee they charge to convert Canadian Dollars to US Dollars and vice versa when clients want to trade U.S-listed securities. The company says they will add premium services in the future, which will most likely feature monthly fees.
You may expect Wealthsimple to earn money from order flow like some of their competition in the US, but according to the company, they don’t have any revenue coming from that front. The company has been vague about its revenue sources, so there are concerns that they may have cash flow problems over the next few years.
However, the 1.5% charge for currency exchange is a hefty fee that adds up nicely when you consider their 1.5-million-strong user base and 8.4 billion in assets.
How Can You Make the Most of Trading Apps?
The commission-free model and the simplistic approach to investment offered by most of these platforms have attracted millions of investors, but not many have what it takes to avoid being just another source of liquidity and revenue to the providers. Here’s what you have to do to increase your chances of success:
- Think long-term with your investments. The current investment climate is such that many people are advertising three-digit returns over short periods, encouraging more short-term thinking in new investors. But playing the long game and taking advantage of compound interest is still the best way to ensure long-term success. Invest in securities and assets with the best long-term prospects and consider tracking a stable index.
- Use money you can afford to lose on high-risk bets. With your long-term portfolio sorted, you can take some high-risk bets (such as margin trading) with the money you can afford to lose. If you succeed with your trades, you can put some of the proceeds into your lower-risk long-term investments.
- Treat your investing with the seriousness it deserves. Underneath the shiny apps, fireworks, and beautiful animations, investing is still a serious business. Don’t allow the intentional dopamine-pleasuring approaches adopted by the various brands to affect your psyche.
Conclusion
Most trading apps make money by providing liquidity to market makers in return for some compensation or charging fees for special features. This means most of the platforms with commission-free trading as a heavily emphasized perk are rarely free in the real sense of the word.
Users often have to pay small fees to enjoy the full range of services, so at best, these apps are running a “freemium” model. There’s nothing wrong with this, but the age-old adage rings true here: “if the service is free, you’re the product.”
