Reddit trolls Wall Street: What went down?
TLDR: The shorts/hedge funds lost, retail and hedge funds (!) won — so some rich people lost money and other rich people made money alongside excited traders from Reddit. And to be very clear, Redditors may have triggered the event but the squeeze was executed by other hedge funds going long on GME. Also we all learned about the limitations of the no cost online brokerage. But I’m struggling to see how this is market manipulation by the establishment specifically targeted against regular traders.
A more detailed take on ‘What the hell is going on with Gamestop?
I’ve been watching the events develop this past week, digging to uncover what is happening with both retail traders and Wall street. Caught in the hype is the stock Gamestop (GME), a struggling mall-based video game store. GME has seen an explosion in price triggered by “YOLO” trading going viral on Reddit r/wallstreetbets, a forum whose members call themselves “retards’’ (an anagram for “traders”). Through coordinating on social media and collectively deciding to send the stock “to the fucking moon” 🚀🌕 its price was catapulted from around $20 at the beginning of January, to $483 by the end of it (that’s a 2000% hike!). One main reason that transpired for choosing GME was that its stock was being shorted heavily by several hedge funds (“shorting” means betting that the price of a stock will go down). And presumably, many redditors, who are gamers themselves, thought it would be ironic to turn GME into a winning position at the expense of billions lost from said hedge funds.
At its peak, Robin Hood, a popular retail trading platform decided to stop people from trading GME, and even attempted to liquidate positions, by force, at a bad price. This, of course, further riled up the army of “vigilante” traders on Reddit, which then caught widespread media attention.
Still today the sentiment inside the group is going strong #diamondhands — with people cheering on each other to spend their stimulus checks and rent money to buy more GME stock and other suddenly loved stocks, such as Black Berry, Nokia and more. The group narrative reflects some kind of battle of the nerds/losers/underdogs vs. wall street/hedge funds/establishment. The forum itself is flooded with memes of epic battle scenes from films like “300” and “The Avengers”, in which “YOLO” traders on Reddit are depicted as heroes taking down the villains.
Especially embarrassed were the hedge-funds who had been short selling GME, and were now unable to cover their positions in the order of billions. Citron Research, a prestigious market research firm, even responded by announcing it will no longer publish their short-trading analysis, out of fear that Redditors, as they say in their own words, would “weaponize their autism” to trade against them, claiming “we can remain retarded for longer than they can stay solvent’’.
If you look at the situation closely, this entire frenzy does shine light on the fact that there are inequalities in the markets. Hedge funds have deep pockets, and regulatory permissions, to trade as they like. But when retail traders try to play the same game, they are faced with the limits of regulatory and liquidity requirements of retail platforms. However, this doesn’t mean that the YOLO traders of Reddit are the heroes they claim to be either — even though they did manage to embarrass ‘a slice’ of the establishment (including regulators, hedge funds and Robinhood itself).
So let’s take a closer look at the events that led up to the YOLO frenzy, and see what we can decipher:
In August 2019, famed investor Michael Bury, who shorted the housing bubble back in 2008 when no one saw it coming, revealed that he was going long, i.e. holding GME, when the general market consensus was for shorting it (again: shorting means to bet that the value of a company will decline). His reasons cited (among other things) GME’s new partnerships with Microsoft and Sony to sell physical discs, and a decent balance sheet.
In July 2020, Reddit user and options trader u/deepfuckingvalue published a fundamental value analysis of GME. He uses sound reasoning to stipulate that the market valuation and sentiment around GME is far more negative than the data shows. I do think he was being a bit too optimistic, but overall he made a strong case for going against shorting the stock. Alas, he is now a multi-millionare and dubbed ‘a fucking legend’ by Redditors.
In November 2020 a popular post regarding GME hit r/wallstreetbets, starting with ‘sup gamblers’. In great detail and sophistication user u/jeffamazon explains how GME’s short is irrationally high, at that point the short was 110% (compare this to the peak short of Tesla and Netflix at 40%). He says that the Reddit community should exploit this and through YOLO trading trigger the big hedge funds to execute the squeeze. He makes very clear that Redditors cannot cause this on their own, but having to work alongside the long hedge funds, stating “this will happen whether or not we participate. I prefer us iditos to be part of history.”
After that we see a continous uptick of the stock, nothing crazy but an optimistic growth partly resulting from the popularity the stock started gaining on Reddit.
Then on January 28, 2021 we experienced the infamous short, followed by a gamma squeeze, resulting in a 1500% increase in GameStops share price over the course of two weeks — to an all time high of $483. This spectacular rise is attributed to the joyful and nihilistic coordinated effort by the r/wallstreetbets and the shoutout “Gamestonk” on Twitter they received from Elon Musk, who they see as some kind of God. I will later go over why it’s extremely unlikely that Redditors alone could drive the price THIS high.
On January 28, Robinhood restricts trading, and faces enormous backlash — from politicians, business people and customers alike. Lawsuits have been filed.
On January 29, Robinhood peddles back on their choice, allowing trading again but in very restricted fashion. They also end up raising a billion from investors and banks to have sufficient funds to serve their customers.
Then on January 30, trading on popular stocks was still very restricted, yet Institutional investors and other wealthy shareholders such as Fidelity Investment made billions with their ownership of GME.
What was Robinhood’s role in this?
For context, the idea behind Robinhood supposedly originated when one of the founders, Baiju Bhatt, witnessed the protests of Occupy Wallstreet during 2011 and became aware of the shortcomings in the financial industry. The 2008 financial crisis was caused by reckless and outsized speculations on the US housing market. There were not many limits on what institutions could trade, and most shockingly, they were bailed out when they were unable to cover their positions. Markets have become more regulated since, but true accountability has not been dished out.
In this wake, Robinhood, who was especially popular amongst the YOLO-traders, decided to halt the buying of GameStop and other heavily shorted stocks, such as Black Berry. Customers who sign up to ‘no cost brokers’ often unknowingly sign arbitration clauses, making it very hard to enforce their rights.
In emails explaining their decision to halt trading to customers, Robinhood claimed to have taken this decision in order to protect its users from increased volatility and heavy speculation.
This is further complicated by the fact that most YOLO-traders were trading on margin (i.e. they were using debt borrowed from Robinhood). This is indeed a huge risk to Robinhood, especially if their traders end up gambling away all their money and causing liquidity shortages. And as 2008 taught us, small people don’t get bailed out.
Further, the liquidity obligations of trading platforms were extremely high, putting them at risk of being unable to meet them. Therefore they had to restrict trading to protect themselves. In this way their choice is understandable. But in my opinion, they were not honest with those facts.
It’s hard for us to imagine that hedge funds would receive similar limitations or such a ‘patronising’ response to their risk-taking. They can trade freely and in comfort because they’re professionals making ‘smart’ money choices. Here I agree with Sen. Elisabeth Warren who called for better rules on market manipulation in general (both retail, and institutional) and enforcement of regulation by the Securities Exchange Commission.
Overall I do believe Robinhood acted unfairly by only allowing the sale of GME at $118 (remember it peaked at $483 and now with restrictions is still at $250). In this way, Robinhood stole millions from their customers and handed it to institutional investors, who thanks to this, were able to cover their positions much more cheaply. Because of all this, I think the backlash against Robinhood is warranted — especially because of their poor use of communication. Their entire branding revolves around ‘democratising investment’ and standing up for retail traders. Yet sadly, in the most heated moments, they did not side with retail traders, and instead took away their freedoms.
Are Redditors causing the price jump, and did they really screw the establishment?
Unfortunately, the romantic story of a group of ‘vigilante’ shitposters taking down massive hedge funds is likely false. After all, a few hedge funds with terrible portfolio risk management are not the entire establishment. I personally doubt that the community collectively had $14 billion to pull this off. In all likelihood, the real story is that of another giant hedge fund eating a medium sized fund, and using a subreddit as a meme cover story. I do believe that the trigger moment occurred through Redditor’s enthusiasm, but the resulting sharp price changes probably come from big money. Hedge funds, after all, compete with each other. There were both long AND short positions on GME. For example, it looks like Blackrock raked in 2.4 billion on their ownership stake, and so did other “establishment” firms. Trading against the short isn’t all that anti-establishment. If anything it’s just common financial practice.
To conclude:
It’s entirely possible that the power of Reddit memes is really that strong, but another more likely possibility is that the short squeeze against Melvin Capital was most likely executed by another big hedge fund who was holding onto their position.
Most likely retail investors will suffer the biggest losses of this, because they will not be able to exit as fast as the long hedge funds currently “backing’’ them. And small investors are likely to lose whatever they invested in GME. Statistics on day trading and platforms like Robinhood show that 97% of traders lose money when timing the market.
