How to Use the New Investing Apps Like Robinhood

Your trades are how self-directed investing apps make money, and they want you to trade often, but experts say there’s good research to suggest that frequent activity is bad for returns.

“There’s an inverse correlation between how frequently you trade and how your investments do,” says Spencer Jakab, author of “The Revolution That Wasn’t: GameStop, Reddit, and the Fleecing of Small Investors.” “It’s been shown in many, many studies that just looking at your account is dangerous to your net worth,” he says.

What’s important is to understand your investing goals, says Steve Windell, the head of behavioral science at Morningstar. “The platforms’ incentive is to have you trade more, and as a consumer, you have to ask yourself, ‘Is my incentive to save or to trade?’” he says.

“Self-directed brokerage sites may not charge commissions, but they can cost you more just through overtrading and overreaction to the news when the best investors will tell you to buy and hold,” Bormann says.

“A lot of people time the market and they want to be in-and-out, in-and-out, in-and-out. And that system does not work out,” Flores says. “What works out best for people is to think about staying invested, especially if you have a long-term horizon.”

To avoid emotional trading you should limit your market-news alerts and avoid acting on advice from social media. News and social media apps live side-by-side with investing apps on smartphones, relaying messages in real time, constantly nudging users to act on the newest info. This instant and constant connection reduces the time it takes from receiving new info, to making a decision based on it (known as friction). 

Frequent market alerts can easily overwhelm users, short-circuiting their critical thinking. It can cause investors to make inadvertently rushed decisions and to fiddle with their investments more often than may be beneficial. 

“Most market news is best seen as entertainment only,” Bormann says. “Removing alerts on news apps can be a good idea so they don’t get to command your attention.” 

You should also be wary of social media, says author Jakab. 

“If you go to social media for advice,” he says, “the advice that receives the most attention is not necessarily the best—it’s the most upvoted, in the case of Reddit. It’s the most clicked on, in the case of YouTube or TikTok. It’s the most telegenic person, the best-known person, perhaps a sort of quote-unquote ‘influencer.’”

Depending on the app, users may be defaulted into services that encourage them to begin trading as quickly as possible or to trade even when they don’t have enough money in their account. 

For example, Robinhood users are automatically defaulted into a lending program called Instant Cash unless they opt out during the onboarding process. With this program, Robinhood extends users up to $1,000 in credit to immediately begin trading, rather than having to wait a few days while their bank transfer into their Robinhood account clears.

If you’d rather not take part in the program, opting out of it isn’t very intuitive. Users have to scroll down to the bottom of one of the app’s onboarding pages. There, another document is embedded. The user then has to scroll down to the bottom of this document to find the opt-out toggle. If they decide to click it, a pop-up appears that describes the non-Instant Cash version of Robinhood as a step down in service. 

Plus, many brokerage accounts have margin trading automatically enabled. “With margin debt you can easily buy more securities than you have cash in the account, and the broker lends you the difference,” Bormann says. The problem is that it can lead to interest charges, or if the value of the securities drops, the broker can send you a margin call or liquidate your positions to cover the debt. “There are many, many investment horror stories that come from overuse of margin,” he says.

Short-term gains get taxed as regular income, which reduces total returns. “It’s one reason frequent trading is harmful,” Bormann says. “If you sell at a loss and then rebuy substantially the same security within a 30-day window, it’s a wash sale and you can’t claim the loss to offset gains,” he says. Many brokers will keep track of wash sales for you, but the consequence is you may end up paying more taxes than expected. “Trading less often makes it less likely you’ll incur short-term gains, or run into wash sale issues,” Bormann says.

For crypto, the exchanges are less regulated and the tax reporting is weaker, but the IRS is getting more active about auditing crypto gains. “The investor should keep precise personal records of their cost basis and profit or loss on every single transaction,” Bormann says. “If not reported, the IRS will come calling eventually!”

On some self-directed investing apps you can sign up for options trading pretty easily. That’s problematic because these are among the riskiest investments around. They are supposed to be available only to investors who can prove their experience, exposure, and track record. Windell says that the screening process many self-directed apps use is too limited, allowing people who might not be suitable for such trading to participate.

“For most investments, the worst outcome is that it goes to zero, but with some options strategies it’s possible to lose even more than you put in,” Bormann says. “The financial models to price options are dense and complicated, so inexperienced traders can end up acting like gamblers because options magnify both gains and losses,” he says.

And the psychological swings are huge because options are time-limited and give big leverage to even small price moves. “In extreme cases, it becomes like a gambling addiction and people lose much more than they can afford,” he says.