Robinhood, a US-based investment firm, has launched margin trading services for investors in the UK, enabling them to pursue higher risks for potentially larger returns.

During the pandemic, Robinhood’s app attracted millions of users by transforming share trading into an engaging, game-like activity. The firm specializes in margin trading, a strategy where investors utilize borrowed funds to amplify their investment potential. This practice can lead to significantly higher profits, but it can also exacerbate losses in adverse market conditions.

Financial experts have raised concerns about the inherent risks of margin trading, cautioning that investors may not fully grasp the possibility of incurring debts that exceed their initial investments.

According to Myron Jobson from Interactive Investor, “Margin trading is best suited for experienced investors due to its complexity and increased risks. While it can enhance profits, it also elevates the risk of significant financial losses.”

Founded in 2013, Robinhood boasts 24 million users in the U.S. It expanded into the UK market in March of this year, offering general investment services but officially commencing margin trading in October after receiving authorization from the Financial Conduct Authority (FCA).

Typically, margin trading is restricted to professional investors due to its high-risk nature. Other companies providing margin trading in the UK include Interactive Brokers, IG, and CMC Markets.

This type of investing enables users to purchase more shares by borrowing from their broker. Should the value of these shares increase, investors reap the full rewards (after deducting loan interest), but if the value declines, they remain liable for the entire borrowed amount.

Laith Khalaf from AJ Bell remarked that margin investing “poses high risks and can amplify losses, potentially exceeding the amount initially invested. Borrowing to invest isn’t a viable long-term approach and should only be pursued under specific circumstances, with investors fully aware of the associated risks.”

Investors using Robinhood’s margin trading must meet certain “appropriateness and eligibility requirements,” including maintaining a minimum account balance of $2,000 (£1,570). All investments must be conducted in dollars.

Robinhood applies an annual interest rate starting at 6% on loans up to $50,000, decreasing gradually to 4.95% for loans exceeding $50 million. These loans are secured against the user’s investments, which could be liquidated to settle the debt in case of a margin call—a concept highlighted in the 2011 film regarding the 2008 financial crisis.

Robinhood stated that it has established loan criteria that align with regulatory requirements. Investors can set their borrowing limits within the app to better manage their investment capital.

In a commitment to customer education, Robinhood emphasizes the importance of understanding the high risks involved prior to engaging in margin trading. “We prioritize providing resources to help customers make informed financial choices,” the firm stated.

According to Jordan Sinclair, President of Robinhood UK, “This service provides a valuable opportunity for qualified customers to diversify and expand their investment portfolios.”

While Robinhood typically does not impose trading fees like many similar platforms, there are other associated charges, such as a $0.278 regulatory fee on trades exceeding $500 and a trading activity fee once users make over 50 trades. A 0.03% third-party fee is applied when making deposits or withdrawals from trading accounts, which is reflected in the exchange rate.

Understanding Margin Trading

If an investor deposits £5,000 into a margin account and borrows an additional £5,000 to purchase 100 shares of a stock priced at £100 each, the total investment would be £10,000.

Should the stock price rise to £125 per share, the investment’s value increases to £12,500. After settling the £5,000 loan plus interest, the investor retains £2,500 in profit, representing a £1,250 gain over a direct £5,000 investment.

Conversely, if the stock declines to £75, the investment is valued at £7,500. The investor retains £2,500 but still owes £5,000 plus interest, resulting in a £2,500 loss beyond what would have been lost without borrowing.

In a scenario where the stock price drops to £0, the total investment value would also be £0, yet the investor would still be responsible for the £5,000 loan, creating a total loss of £10,000, exceeding the £5,000 loss if they had not borrowed.

Ian Cook from Quilter Cheviot urges caution, asserting that while maximizing potential returns can seem attractive, investors must also consider the risks of margin calls or forced liquidation of their holdings in declining markets.

Currently, the FCA permits retail margin trading, and it is actively monitoring the retail market to gain insights into customer demand.

Recently, Robinhood’s CEO Vlad Tenev expressed confidence that the company could effectively serve as a “financial home” for UK customers.