How Robinhood investors robbed themselves

Back in 2020 when millions of mostly young people opened brokerage accounts for the first time while sheltering from the Covid-19 pandemic, it seemed like they could do no wrong, even as some legendary investors could do no right. Dave “Day Trader” Portnoy poked the most revered one of them all to his millions of Twitter followers:

“I’m sure Warren Buffett is a great guy but when it comes to stocks he’s washed up. I’m the captain now.”

And it wasn’t just anecdotal. Noah Weidner, writer of the Business As Usual newsletter and now a member of the editorial team at Stocktwits, quantified the effect by creating the hypothetical “RH Top 100 Fund,” an equal weight index of top stocks most held by Robinhood’s customers. It rose by 101.77% in 2020, about six times the S&P 500’s performance (though it did lag the then red-hot Ark Innovation ETF run by Cathie Wood).

Robinhood has since curtailed the data it shares, but Mr. Weidner has been able to keep track of some of it manually. In what some contend is part of its psychological toolbox that induces people to trade excessively—stoking FOMO, the fear of missing out—Robinhood tells customers what others are doing on the platform. The results aren’t pretty.

Many stocks that joined the top-100 list after strong performances at some point in 2021, such as Clover Health Investments, Coinbase and even Robinhood itself, which went public last summer, have since faded sharply. The broker’s shares have lost more than three-quarters of their value since peaking shortly after the IPO. On average, those 27 stocks are down by 21% just this month.

And then there are the stocks that fell off of the list. For example, Mr. Buffett’s Berkshire Hathaway dropped out of the top 100 after lagging the market in 2020. It has since appreciated by 32%, handily outperforming the market. So have several exchange-traded funds tracking crude oil that slumped badly in 2020. The United States Oil Fund is up by 84% since the start of 2021, and some leveraged exchange-traded notes tracking energy once favored by Robinhood investors have done far better than that. Financial firms like Wells Fargo that slumped in 2020 round out the list—clearly to their former shareholders’ regret.

Robinhood wouldn’t share data on actual performance of its customers, but Mr. Weidner’s calculations show that crowd-following behavior helped them and then hurt them. The latter outcome was baked into their behavior as influenced by the investing app, according to an academic paper by Brad Barber, Terrance Odean, Xing Huang and Chris Schwarz. They note that inexperienced investors are more likely to be influenced by what they see others doing and that Robinhood’s “Top Movers” are traded disproportionately. And, because trading is so frictionless on the app, they tend not to rely on critical thinking as much as more seasoned investors. They also trade frequently—about 40 times as much per dollar in their accounts compared with a customer of Charles Schwab, based on data from early 2020.

There might be a way to make money from the paper’s observations, or at least avoid losing it. The authors identify “herding events’’ among Robinhood’s customers. Selling after one of the 4,884 such instances they observed and buying the stock back five days later would earn an average return of 3.5% with a gain 63% of the time.

As those who stuck with the 91-year-old Mr. Buffett in rocky 2020 would agree, slow and steady wins the race.