There are a lot of great reasons to open up an account on Robinhood.
The popular stock brokerage app has democratized investing by being the first to offer no-commission trades, and has won over the millennial generation with its mobile-first, easy-to-use platform that avoids much of the traditional stuffiness of Wall Street. The app even gives you a free stock for signing up.
If you're new to investing and just signed up for a Robinhood account, you just took a great first step, but there are a number of things you should be aware of before you dive in full-tilt. Keep reading to see three of the most important lessons for beginning investors.
1. Beware of margin trading
There are two kinds of brokerage accounts -- cash and margin. With a cash account, you can only trade with money that you have invested in that account. In a margin account, however, you can borrow money from the brokerage based on your holdings in the account to add to your buying power.
It's easy to see the appeal of margin trading. If you see a good opportunity, you could multiply your potential gains with a margin account, but there are outsize risks to investing this way. If your no-brainer purchase goes sour -- and believe me, it can -- and the value of your holdings falls to a certain level, the brokerage can issue a margin call, meaning the brokerage requires you to repay the money you borrowed to buy the stock that went down. Unless you have cash sitting around to pay the brokerage back, you'll be forced to liquidate your holdings to meet the margin call, meaning you'll have to sell your stocks for (much) less than you bought them for.
You might think the chances of this happening are rare, but look at what happened in March when the S&P 500 crashed 37% in little more than a month. In addition, plenty of supposedly safe blue-chip stocks fell more than 50%.
A standard Robinhood account does not offer margin trading, but it is available with Robinhood Gold, the company's premium subscription service. New investors, and even veteran ones, are better off avoiding it, and the same is true for short-selling and selling naked options.
2. The current market environment isn't normal
The springtime recovery in the stock market has attracted new investors to Robinhood and other platforms, as the boom in a number of growth stocks allowed investors to double or triple their money in a matter of weeks.
For example, Tesla (NASDAQ: TSLA), a popular Robinhood stock, jumped from a low of $350 on March 18 to a high of $1,795 on July 13, a gain of more than 400%. That surge has led to similar gains in other electric car stocks like Nikola, Workhorse, and NIO.
However, in a normal market environment it's very rare for stocks, especially well-known large caps, to see gains of four or five times in just a few months. Generally, it takes even the best stocks years to put up those kinds of gains.
There's still an unusual level of market volatility, or the extent to which stocks swing up and down. According to the market's preferred volatility measurement, the CBOE S&P 500 Market Volatility (VOLATILITYINDICES: ^VIX), better known as the VIX, uncertainty is still historically elevated, though it's come down substantially from the height of the crisis.
For individual stocks, volatility levels are even higher, as the pandemic has created a unique situation that favors certain "stay-at-home" stocks like Netflix (NASDAQ: NFLX) and Amazon (NASDAQ: AMZN), while pressuring others like Disney and Starbucks (NASDAQ: SBUX). These segments seem to move in opposite directions these days, though which way depends on the news of the day and what it portends for the pandemic.
New investors should also be aware that there are a number of bubble-like conditions in the market today, and there is certainly no guarantee that stocks will move higher from here.
3. Free trades are great -- but don't get carried away
Robinhood's greatest innovation was free stock trades, which gave the platform a clear advantage over more traditional brokerages, which often charged several dollars for a trade. Though a number of brokerages now offer free trades, the feature is still mostly closely associated with Robinhood, and it continues to draw new investors to the app.
However, no-fee commissions shouldn't be a reason to trade constantly. The best way to make money in the stock market is by holding high-quality stocks for a long period of time. There's a tax advantage in this, as long-term capital gains rates, which require holding an investment for more than a year, are generally lower than short-term rates, which are taxed like ordinary income.
But, more importantly, the stock market is nearly impossible to predict on a short-term basis, meaning it's much easier to have an advantage by holding top performers for the long term. While it may seem appealing to book a quick 20% gain on a stock that has just jumped, or even take profits after a surge like the one Tesla just experienced, true life-changing gains are made by holding top stocks for decades.
A number of popular names have turned $1,000 into $100,000 or much more over the years, including Netflix, Amazon, and Starbucks. There's no way to know when stocks like these will break out, and selling them has almost always been a mistake.
The good news
Opening up a Robinhood account was a great move. Getting started investing can be one of the most rewarding decisions in your life, financially and in other ways. Be prepared to learn and to be wrong at least sometimes, and remember that securing a better financial future is a lifelong journey, not a one-time bet at the poker table.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Amazon, Netflix, Starbucks, and Walt Disney. The Motley Fool owns shares of and recommends Amazon, Netflix, Starbucks, Tesla, and Walt Disney and recommends the following options: long January 2021 $60 calls on Walt Disney, short January 2022 $1940 calls on Amazon, long January 2022 $1920 calls on Amazon, and short October 2020 $125 calls on Walt Disney. The Motley Fool has a disclosure policy.
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