What the hell is going on with WSB?
Tragic Letters from the Outskirts of the New Economy
Dear Techconomist,
What’s going on with Robinhood investors and Wallstreetbets? Why did Robinhood suspend trading on stocks like Gamestop and AMC? They cost me a lot of money. I feel cheated.
Sincerely,
Rich Tendies
Introduction
Dear Tendies,
Dope name. Favorite so far! Let me start off by saying this, the current retail consumer fad will not end well. There are really two things you’re not allowed to do as a private investor: trade with insider knowledge and manipulate markets through providing a false signal. There’s a very clear case that the activities performed by the Wallstreetbets crowd amount to market manipulation. This is a strategy as old as the market. It’s in Malkiel’s A Random Walk Down Wall Street, published in the 50’s. It’s even in Graham’s Securities Analysis originally published in the 1930s.
A group of investors gets together and convinces each other to buy a stock in an effort to raise its price. It started in New York cigar clubs; then it went to Yahoo message boards; now, it’s on Reddit. This is not a new idea. It’s a textbook example of a Securities and Exchange Commission case waiting to happen, and people will go to jail.
You might think this is unfair. The market is just a casino anyways, right? You are half right. As you can read in the brilliant and recently published book The Biggest Bluff, many studies have shown that casino poker requires far more information and understanding than investing. However while the investing world is a bit random and opaque, it is in no way pointless. It’s a great way to bring together individuals who have different risk preferences and capital values to create value.
The Economics of what the Market really Does
Listen to me! Talking like a sweaty post-doc giving a job seminar and flashing some vocab words! Just to be clear, the market exists for one purpose: it efficiently prices capital and risk. This means that if someone doesn’t have much money or doesn’t like to take risk, they use the market to sell that risk or get that money from another individual who has assets or loves risk. It’s all about differences in preferences and pooling resources to make us all better off. Maybe you need funding for your business because you need to expand? There’s a market for that! Maybe you are worried the price of aluminum will go up and want to protect yourself? There’s a market for that! Maybe you cannot pay your employees today because you cannot get someone to pay you yet? There’s a market for that!
The market serves an important purpose, and in many ways people get hurt when it stops serving that purpose. I will be honest: I think it’s in the best interest of society that everyone should have access to equity markets. Futures markets have gatekeeping. It can go pretty poorly sometimes. If the existence of retail speculators stops the market from correctly pricing capital, equity markets might move in that direction. Who is more likely to lose their ability to trade? The uber-rich sitting in their ivory towers or the Uber-drivers checking Reddit in their freetime? Exactly. But there’s a bigger issue here.
The Flaw in the Wall Street Bets Manifesto
Let me be very clear. This is not a rebellion against the rich. This is the rich serving up the poor on a silver platter to be eaten with a silver spoon. You are the meal. When this is all over, the market will equilibrate, rich people will remain rich and get richer. The retail investors will get eaten.
I am not saying this because I pretend markets are brilliant bastions of efficiency. There’s an entire subfield of economics devoted to the idea that market inefficiency is a very real thing. It’s not even a debate anymore in the field. I am saying this because you don’t have access to serious capital or resources. If you own 100 shares of GME and Gamestop stock loses 50 bucks, you are suddenly out five thousand dollars. That means something to you. It does not mean anything to the banks. They could lose billions and not care.
Leverage and how it can Save or Destroy you
It’s time to introduce you to the magic of leverage, which allows a small amount of force to move a large object. Leverage allows a small amount of money to make large purchases. The investment banks and hedge funds have tons of money around and can easily borrow to get more. They can lose billions of dollars and not care. It’s other people’s money. That’s the business. The bank is not losing money. It has found a way to hedge the risk, so they never get hurt. When Robinhood took down trading, it was a case of too little leverage. They didn’t have a choice. They had to shut down trading.
One of the fascinating idiosyncrasies of the 21st century stock market is that some people trade with a timing disadvantage. In a market where information is everything, small amounts of time matter. When you put a trade in on Robinhood, they have a bit of leeway as to when they fill your trade because of limits on volume trading. This means that they can sell the trade to trading house, which in turn can use that trade to satisfy larger clients. The problem comes in when there is tons of activity on a few stocks, say GME or AMC. Now, you have a problem. Now, Robinhood must pay to trade, not the other way around. Very quickly Robinhood’s business model breaks, and it must borrow to fill trades. When GME-mania was going on, Robinhood’s creditors asked for higher rates and additional collateral. Essentially if Robinhood let you keep trading, it would have gone belly up as it could not pay its debts.
The Right Way to Invest: Tips for Serious Investors
If you really are serious about investing, stay away from Robinhood! Schwab, TD Ameritrade, Navy Federal Credit, anywhere but Robinhood and Cashapp. These companies are turning the investment experience into a casino. Robinhood does not make money by selling ads. It does not make money by selling data. It does not make money by earning trading fees. It makes money by selling the ability to fill your trades, and it lied about that for a while. Robinhood is a machine that takes advantage of innocent people by misleading them about the market. Do not mess with Robinhood. They didn’t cheat you by suspending trading, but oh did they take advantage of you. You are not Kevin Spacey in 21 (thank goodness now, right?). You are not going to beat the market.
I do believe the market can be beat. I believe it can be beat consistently. Look at LTCM. Look at Renaissance Tech. Look at Michael Burry. Look at Berkshire. Think about Bill Achkan. I do not believe small investors should be managing their own portfolios. Think of this like Daily Fantasy. Unless you are willing to commit to making being the best and most informed person your actual job, you will not come out on top unless you buy index funds. Maybe you think you have a winning strategy. It’s not likely, but maybe you do. Get an account with Charles Schwab or TD Ameritrade. Put money in the account starting with low-risk investments or index funds. Watch the market and make a calculation of how your investments do compared to the strategy you would choose. Don’t change the strategy mid-cycle or trade the day the strategy does well. Wait until it consistently works. Then and only then, implement. It was true 1990s with the tech boom, it’s true now: small retail investors don’t beat the market, but if they buy index funds, they can match it. Call Vanguard! They’ll fix you up. Let them know Techconomist sent you!
Never hold Cash! Never, never, never!
I want to leave with one last piece of advice, and this is the most important. Under no circumstances short of societal meltdown do I ever recommend being out of the market. Stay invested. Don’t ever hold cash you don’t need. You can put it in Bitcoin. You can put it in equities. You can put it in a currency fund. You can put it in a REIT or a house or whatever you want. Do not leave your money under the mattress. Cash is the world’s worst investment strategy. Everything I know leads to believe that no one can effectively predict a large-scale market downturn.
We all have a grandpa or an uncle or a friend in our lives who always predicts a market collapse. Economists have predicted 70 out of the past 10 recessions. You cannot live your life as a pessimist. I know. I’ve tried. It cost me a lot of forgone Bitcoin. It cost me a ton of stock gains. Do the smart thing. Go to your bank and get a financial advisor. Try to make sure she’s a fiduciary. You want someone managing your money with your interests at heart. The right person will start by asking what matters to you. If you need advice on whether get a Roth-IRA, your financial advisor will point you in the right direction. If you want a baby and mortgage but are concerned about payments, a good financial advisor will help you along the way. If you want to go to grad school and need a way to fund that, your financial advisor can point you that way too. Ultimately, this is what investing is about; how can risk and capital be spread around the pool of market participants to make everyone better off. It’s about preferences and priorities. Make yours heard! I feel sorry for you Rich Tendies. I know you feel cheated, but you learned an important lesson. Take that with you. Be smarter next time, and keep reading.
Your partner in democratization of finance,
-Techconomist
If you want to get in touch with me, email techconomist@gmail.com.
