The Reddit drama with GameStop and AMC has many people captivated, and it’s fascinating because nothing like this has ever happened. The perception that Reddit is really taking on Wall Street is overblown, but identifying “good guys” and “bad guys” isn’t so simple.
A group on the website Reddit called WallStreetBets decided it would be fun to go after hedge funds betting against small stocks like GameStop and AMC. One way to bet against a stock is to sell it, borrow shares to deliver to the person you sold it to, and then buy the stock in the future to pay off the loan. That’s called short selling, and it’s very common among institutional investors such as hedge funds.
Short sellers are often vilified, which isn’t warranted. The downward pressure of short selling is one way markets keep stocks priced appropriately. In fact, short sellers are sometimes credited with finding corporate fraud and bringing it to light. In the case of stocks like GameStop, they were simply viewed as overvalued by a couple of hedge funds.
The WallStreetBets group decided to take out some vigilante justice on short sellers. They were helped by the simple fact that these were small stocks. When short sellers are wrong, they lose money fast. These hedge funds were forced to buy shares to close the trade, this buying pressure only pushes the price up further.
As far as “justice” goes, it may read as good drama, but these games go on among institutional traders all the time as they may seek to bust various trades by competitors. This was interesting because it was accomplished by novices with relatively small amounts of money acting as a “mob”. Many of these people had no idea what they were doing other than buying a stock that looked like it would make them money, and feeling like they were sticking it to the man.
The sad story is that eventually this will run it’s course, and as we see in gambling, these novices are likely to lose money they can’t afford to lose. This isn’t helped by testimonials you can see on WallStreetBets by users discussing how the money changed their life.
Now there is another interesting side to this that does have to do with small investors. Robinhood offers “free trading” as do many brokerages these days. That always sounds like a great deal, but the small investor is the product in this world, and the market makers and hedge funds are the consumers. Large firms that facilitate trading across the stock market are willing to pay for trade volumes, they’re paying Robinhood, and many other brokerages, for the trade flow.
Large institutions trade very rapidly over very short periods of time, this can only happen when there is an ocean of trade volume. So, the trades themselves, regardless of direction, provide the mass enabling this process. This is why the trades are “free” to the small investor.
In this little story Robinhood’s mistake was to limit trading in GameStop and others. While they can claim to be protecting clients, the other side of the story is that Robinhood itself is owned by large investors including…you guessed it, large institutions that pay for trade flow.
There has been a lot of discussion of the good guys and bad guys here, and as you can see, when the onion is peeled back the story becomes much more complex.
The hedge funds that shorted the GameStops of the world were doing what hedge funds do all day every day, and short selling can actually be good for markets. They did get a little greedy here, and happened to be in the wrong place at the wrong time, but hedge funds blow up and reconstitute themselves all of the time.
Robinhood got itself into a pickle because they have gamified trading, and it’s no game. The huge rush into such a small stock caused them operational issues that needed big money, and they bent to the will of their owners who had skin in the same game. Limiting a client’s access to trading is generally bad in a free market system.
The reddit WallStreetBets group? A wild mob during a time where mob scenes are playing out in our culture. Some of these people will make money, many will ultimately get creamed, but it’s difficult to know what to make of it because we’ve never seen the likes of this animal. Institutional investors have already infiltrated this group, and you can bet they’ll try to use it to their advantage until the gig is up. As this is being written WallStreetBets is going after silver (the metal), this should be interesting.
So as people try to sum this up into a simple Tweet, please realize it’s not as simple as it may appear.
Long term investing is the best approach for most investors. Buoyant Financial would be quite happy in a world where stocks only traded once a week. Leave the foolish trading games to the gamers. At Buoyant Financial this isn’t a game, it’s your financial life.
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