Wallstreet is one of the most respected trading markets in the world. Thousands of professional investors read the markets and ply their trade daily, often making a fortune in the process.
It’s usually unheard of for independent small traders to ever get one-up on these giants of the trade industry. In fact, the pros often refer to these indie investors as ‘’dumb money’’, as they are usually destined to lose against the highly compensated analysts and traders who work the stocks for a living.
Any investment can be a risky game, especially when high-risk decisions are made without giving thought to the fact that independent traders may not be as ‘’dumb’’ as everyone thinks. In fact, some share shorting practices have come back to bite prominent hedge funders, resulting in a massive $20 billion loss for Wallstreet.
What is Shorting of Stocks?
Before starting, it is vital that readers understand what “Shorting Stock” is, as this investment term forms the basis for the entire debacle.
When an investor decides to short stocks, it means that they borrow stock from a broker without actually paying for it. They then sell the stock with the gamble that its price will fall. Once the contracted time period is up, they must buy the stock back at the current market price.
Quick Fact: Shorting is a risky bet. When buying and selling stocks regularly, you only stand to lose up to 100% of your money. When shorting stocks, you could lose far more, depending on the growth of the stock before you manage to buy it back.
Hedge funders will often do this if they feel the stocks will drop. This way they eventually pay the broker a lower price after having already made a profit on the deal. Often, these bets pay off, making the investors millions in the process.
You Reddit Here
Reddit is a social news platform where users can post news pieces and blog posts about various topics that are close to their hearts. Readers can then upvote or downvote their posts, which will either leave them trending as ‘hot news’ or see the posts dwindle away in a short time.
Some Sub-Reddit pages deal specifically with certain industries, such as gaming, politics, and investments. It is on the Sub-Reddit page ‘’WallStreetBets’’ that the story begins to unfold with a series of posts that trended well thanks to popular appeal.
The year 2020 and the Coronavirus Pandemic was very hard on businesses. GameStop, a chain video gaming store in the USA, went through really dark times, seeing their stock prices drop significantly.
Hedge funders saw this as an opportunity to short their stock, as it seemed like there was no way back for the gaming company. They first borrowed and then sold the stocks at between $4 and $11 a share (which is what they were worth last year) with the aim of buying them back cheaper at a later stage.
Traders from WallStreetBets noticed that the GameStop stock was moving and recognised that institutional investors were hedging funds and shorting stock on GameStop shares. Using the voice afforded them by Reddit, they urged their communities and friends to buy up as much stock as they could and gang up on the investors, who they believed, had “too much power in the market”.
Quick Fact: WallStreetBets is no small community. They boast a current followership of around 3 million readers and supporters.
Well, the plan worked and GameStop’s value grew by an astronomical 2000% in a matter of weeks, leaving the hedgers with the need to pay back massively inflated prices on stocks that were borrowed, resulting in losses of up to $20 billion. The stock price of GameStop rose to over $350 at its peak but has nestled back down to $225 as of the 2nd of February 2021.
Curbing the Severity by a Margin
As a result of the massively volatile swings in the market, trading houses may halt trading on certain stocks to protect their interests. Exchanges halt trading fairly regularly, often because they are required to have a certain percentage of capital on hand to support public trading on their platforms on any given day. If trades become unexpectantly volatile, they will shut shop on those trades for a few minutes or hours as a way to ‘steady the ship’.
Free investment app, Robinhood, came under great backlash when they halted trades on GameStop and various other stocks towards the end of January 2021, due to tapped credit lines.
While individual investors accused the exchange of collusion with the corrupt, the company called for compassion and apologised for their need to restrict these trades. Chief Executive of Robinhood, Vlad Tenev said:
"We understand our customers are upset, we're doing what we can to re-enable buying in these names. We want to be clear in the communications, and I own that we should have been out there a little bit sooner."
The trade halts have annoyed many potential investors and have led to high profile celebrities shaming the exchange publically. Two of their customers have even sued them for damages as a result of the restrictive trading.
While Robinhood was not the only exchange to halt trading on GameStop and several other trades, it has received the greatest backlash thanks to its popularity in the market space among smaller traders and independent marketers. It is, however, the market instigators that should be most concerned right now!
Reddit Readers Beware
The SEC is keeping a close eye on this entire debacle. It is not the exchanges that run the risk of penalty, as much as the Reddit instigators. While there is no official statement by the regulator that they are investigating suspicious behaviour linked to market manipulation, it could raise its ugly head.
Quick Fact: Market Manipulation happens when someone tries to create excitement and generate activity in a particular stock for the purpose of luring buyers to purchase shares and drive-up the price.
If the SEC regulator sees fit, they could launch an investigation to ascertain whether the new GameStop investors that incited the crowds via social media were involved in a pump-and-dump scheme. Whereby they would have hyped up the community, driven up the prices, and then sold their stocks off the back of a manipulated market for massive gains.
An investigation would also have to cover whether false or misleading statements were made to drive up the stock price. If found to be the case, this would result in a fraud charge.
Finding a Balance
For a long time, professionals in Wall Street have looked down their noses at independent investors. Their derogatory terms ought perhaps to be changed, as the community and its hobby-investors have certainly shown that the mighty can fall and have showcased that not only smaller investors can take “dumb money” bets.