Retail investing is booming. Here's what Wall Street is expected to do with 10 million new members

Published Mon, Jan 11 20212:04 PM EST

(This story is for CNBC Pro subscribers only.) 2020 was a red hot time for the retail investing industry, but 2021 could bring another solid year as traders stick around after the pandemic. Retail trading just wrapped up a record year in 2020, as unprecedented market volatility and Covid-19 lockdowns created a unique opportunity for regular investors to play stocks' unlikely but epic comeback. Public e-brokers Charles Schwab , Interactive Brokers , now-acquired E-Trade and TD Ameritrade and private stock investing firms Robinhood and Fidelity experienced explosive account and trading volume growth last year even with low barriers to entry into the retail investing space. "2020 ended up being the perfect storm for retail trading," said JMP Securities analyst Devin Ryan. "It started with the extreme volatility which typically is a strong corollary with trading volume. The pandemic added an additional thread where the mass wave of individuals were working from home, paired with the convenience of being able to trade online." JMP Securities estimates the brokerage industry added roughly 10 million new clients in 2020, according to app download data from SimilarWeb. About 6 million of those new investors are operating on millennial-favored stock trading app Robinhood, which pioneered "free commission trading" back in 2013. "I think people underestimate just how much of a catalyst having a free offering out there is, so that you can buy and sell stocks for basically 'free,'" said Tim Welsh, founder and CEO of wealth management consulting firm Nexus Strategy. "If you look back to 1999 and 2000, the dot-com era, that's when this stuff first existed. We saw the same sort of exuberance. Now its all free." Record accounts and trading The major online brokers — Charles Schwab, TD Ameritrade, Etrade, Fidelity and Robinhood — saw new accounts spike in the first quarter, when stocks experienced a dismal rout and subsequent rebound. This account growth continued through the end of 2020 as stocks clawed back their losses, as young and sometimes inexperienced investors saw the coronavirus downturn as an entry point into the world of investing. Citi chief U.S. equity strategist Tobias Levkovich called the pandemic a "generational-buying moment" for those without much background in the equity space. Daily active revenue trades soared as investors were stuck at home in the absence of sports, even using their stimulus checks to trade . Piper Sandler estimates retail volumes grew 138% in the first 11 months of 2020 compared to the same period a year ago. "Even if we do see some moderation in volatility in 2021, we think the trading volumes are going to be quite higher than they were pre-pandemic," Ryan added. The new investors in the market are not all your typical White male. Robinhood told CNBC the number of woman using its app tripled in 2020. Plus, many of the news accounts were from a younger demographic. "There's a huge level of diversity with the new entrants to the market and I think that terrific if you appreciate that the earlier an investor has access to financial services the better long term opportunity they have to succeed," said Ryan. Charles Schwab, which has a market value of $106 billion, gained about 14% and Interactive Brokers, with a market capitalization of $428 million, gained more than 30% in 2020. Schwab acquired TD Ameritrade for $26 billion, a 17% premium for share, and Morgan Stanley bought E-Trade for $13 billion, representing a 30% premium. 'A great year of learning' Of course, the incredible year did not come without its challenges. All of the major brokerages experienced outages at some point during the year due to high volumes of trading. Many clients were left frustrated when missing out on big market days. "I think the infrastructure of the entire industry was pushed to the max this year with the record level of new customers, record level of engagement and ultimately record trading activity," said Ryan. Infrastructure is expected to be a focus for major brokers which need to have the capabilities to facilitate the record number of new clients and high frequency of trading. Brokers have already taken steps in beefing up infrastructure capabilities, services, and other cyber aspects of the business. "It's a process so this doesn't happen in one quarter or even one year but we think the industry did take steps forward during the course of 2020 and we think is entering 2021 in a much better spot," said Ryan. Robinhood also experienced backlash for its lack of educational programs and marketing labels. "With that access comes great responsibility. This year was a terrific year but also a great year of learning for the entire industry and I expect that the leading firms are going to walk out of this year with a number of positive lessons learned where they continue to improve their platforms," Ryan added. 2021 and beyond Many analysts expect retail trading to continue to expand in 2021 and not return to levels before the dropping of commissions and before the pandemic. "Barring a major market correction, we see many of the trends persisting into 2021," Piper Sandler analyst Richard Repetto said in a note to clients. "We expect equity/equity option volume to remain elevated with zero commissions being the main driver of sustained increase (though some normalization could occur if 'work from home' subsides and volatility declines)." Yet, in an increasingly competitive industry, brokers will need to focus on the convergence of business models, where someday Charles Schwab and Robinhood can serve their customers with other financial tech options, analysts told CNBC. "We see firms offering more bank-like services and more educational tools and other personal finance products which we think ultimately will helped the end customer manage more of their financial life beyond just trading," said Ryan. Over time, the online brokers want to work with the highest percentage of a customers wallet as possible for a more holistic relationship. Morgan Stanley buying E-Trade was a major step for the institutional bank to keep up with the digital capabilities of a brokerage firm. "Your seeing many of the legacy incumbent firms looking to expand their capabilities across the financial services spectrum, to help the customer optimize their assets and liabilities. Many of the fintech firms that maybe started with one or two specific products or capabilities expanding the set of products and capabilities so they can work with the customer in other ways," said Ryan. In addition to the larger firms like Morgan Stanley and Goldman Sachs moving downstream with more digital reach towards consumers, other fintech companies are expanding their reach. Chime, a start-up that delivers banking services through mobile phones, became the highest valued fintech company in the U.S. , surpassing Robinhood. Square's Cash App is growing and payments company PayPal is expanding into crypto trading. "We see a lot of convergence amongst the models where in 10 years many of these companies may look a lot similar to each other than they do today and I think that will be the case if they are successful," said Ryan. 'It only goes up' Other analysts don't see the new accounts as permanent. Welsh, who is vocal about the dangers of the 'gamification' of trading, warned newbie investors about the next downturn. Since the market bottom, stocks have mainly chugged upward but market cycles have corrections and pullbacks that could weed out the new investors. "All we need is just one big market break and that will wash out all the excesses just like it always does," said Welsh. "Right now, we haven't seen that, there hasn't been a big decline so people still think it only goes up." "Stocks only go up, until they don't," added Welsh. "That's when the big reckoning with happen and we'll see people who seriously lost money and they'll say 'that was dumb, I'm not going to do that again'." Stock of the year High flying electric carmaker Tesla was the most loved stock among retail traders last year, according to Apex Clearing. Tesla was ranked the #1 stock for each generation, beating Apple for the first time. Shares of Tesla gained nearly 750% in 2020 as the Elon Musk-led tech giant notched three consecutive profitable quarters and joined the S & P 500. However, speculative names like Tesla weren't the only type of investments retail traders made in 2020. Institutional investors were surprised by the novice investors' decision to buy shares of beaten down names from the pandemic like airlines and hotel operators. Robinhood's plans for public Robinhood is expected to go public this year; however, the highly valued Silicon Valley start-up could face challenges due to recent regulatory issues. Last month, the Securities and Exchange Commission charged Robinhood with deceiving customers about how the stock trading app makes money and failing to deliver the promised best execution of trades. Robinhood agreed to pay a $65 million civil penalty. Robinhood, and the rest of the online brokerage industry, rely on what's known as payment for order flow as their profit engine in lieu of commissions. Payment for order flow in Robinhood biggest revenue source; however, it is unclear if the "commission-free trading" pioneer makes a profit. Public markets don't always punish companies for a lack of profit, but regulatory pains might force Robinhood to find another flow of revenue. The SEC's charges came a day after Massachusetts regulators filed a complaint accusing the trading app of predatory marketing on inexperienced investors. Robinhood was last valued around $20 billion, according to Reuters . — with reporting from CNBC's Kate Rooney and Nate Rattner.

The Robinhood app on IOS and Android

Source: Robinhood

(This story is for CNBC Pro subscribers only.)

2020 was a red hot time for the retail investing industry, but 2021 could bring another solid year as traders stick around after the pandemic.

Retail trading just wrapped up a record year in 2020, as unprecedented market volatility and Covid-19 lockdowns created a unique opportunity for regular investors to play stocks' unlikely but epic comeback.