Reddit Versus Wall Street
As the economy progresses into an age marked by the rise of streaming services and the collapse of brick-and-mortar empires like Blockbuster Video, consumers have swiftly adapted and embraced new technology. GameStop, a once thriving video game retailer with storefronts at many local malls, is suffering a similar fate. In December 2020, the video game chain announced that it would close up to 1,000 stores by the end of its fiscal year in March 2021. (Lauren Gray, Yahoo!). Even so, in January 2021, many investors woke to news headlines declaring a GameStop stock (“GME”) buying craze. Within six days, GME’s price soared from $43.03 on January 21st to $347.51 on January 27th, a 708% increase. (Google Finance). What happened?
Melvin Capital—a hedge fund—and other professional investors were caught short-selling GameStop. (Pippa Stevens and Leslie Picker, CNBC). Hedge funds frequently “short sell” stocks. A hedge fund is an investment vehicle that earns profits through the use of non-traditional strategies like short selling typically available only to accredited investors and wealthy individuals. (Jason Fernando, Investopedia). A short sell occurs when a financial institution or individual borrows a security via a margin account—an account where the institution or individual uses borrowed money or securities creating leverage. (Cory Mitchell, Investopedia). The security is then sold in the market under the belief that the security’s price will decline, and then bought again at some point in the future, creating a profit. (Brian Beers, Investopedia).
But Melvin Capital had a hidden antagonist: WallStreetBets, a group on forum website Reddit, self-described as a “community for making money and being amused while doing it. Or, realistically, a place to come and upvote memes when your portfolio is down.” (Reddit). WallStreetBets and other retail traders—individual traders trading securities for personal accounts, as opposed to institutional traders trading for institutions—noticed Melvin Capital and other hedge funds heavily short selling GME. (Emily Stewart, Vox; Kristina Zucchi, Investopedia). Through various posts on Reddit, WallStreetBets members and other retail traders decided to work together in an attempt to ruin the shorts. Id. In mid-January, the Reddit users bought GME, causing it to increase in value and generate a profit when they would eventually sell GME for a higher price. Id. This trend progressed because buyers continued purchasing GME in the belief that the stock price would continue rising because of its popularity. Id. In fact, one Reddit user managed to turn $53,566 into $11.2 million due to the resulting inflation of GME. (Brandon Kochkodin, Bloomberg). These actions caused the short sellers to cover, or close, their short positions. (Adam Hayes, Investopedia). Covering allows short sellers to prevent further losses in the event that the stock price increases instead of decreases, as seen with GME. Id. Otherwise, if the short position closes at a higher price, the short sellers lose money because short selling is only profitable if the stock is sold at a lower price. Id.
Because Reddit users, and eventually members of the general public, inflated GME, Melvin Capital lost $4.5 billion of its total $12.5 billion value in January. (Juliet Chung, Wall Street Journal). Citadel LLC—Melvin Capital’s partner group—and Point72 Asset Management infused $2.75 billion into Melvin Capital as an emergency measure after the hedge fund was forced to sell its GameStop stocks in order to close its position and protect against further losses, indicating a short squeeze. (Id.; Yun Li, CNBC). A short squeeze “occurs when a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall, to buy it in order to forestall even greater losses.” (Cory Mitchell, Investopedia).
In addition to earning an easy profit, WallStreetBets’ motive may have been to squeeze finance elites. Id. Some economists view short selling as an integral part of an efficient market. (Id.; Bloomberg, Fortune). Others argue that short selling is necessary to protect against falling stock prices. Id. However, some investors and commentators believe short selling is unethical, because the process “is a bet against growth.” (Brian Beers, Investopedia). It appears WallStreetBets members fall into the latter category. After declaring Melvin Capital the enemy, one Reddit user posted “Only 47% left to go!!” following Melvin Capital’s multi-billion dollar loss, referring to the idea that Reddit users desired to continue squeezing the rest of Melvin Capital’s assets. (Juliet Chung, Wall Street Journal). Another user had strong words for Melvin Capital, stating: “You’re a firm who makes money off of exploiting a company and manipulating markets and media to your advantage. Your continued existence is a sharp reminder that the ones in charge of so much hardship during the ’08 crisis were not punished.” (Will Daniel, Markets Insider).
Against the wishes of many, Robinhood, the smartphone app used by many of the Reddit users engaged in GME’s inflation, then restricted the sale of GME and other stocks that were similarly propped up by WallStreetBets. (Emily Stewart and Rani Molla, Vox). Robinhood is a popular investment app for retail traders because it allows users to buy and sell stocks free of commission fees. (Robinhood). Robinhood explained that it did not want to restrict the sale of these stocks, but rather, “due to the volatility of these stocks, the company was required to come up with 10 times the deposit requirements it had a week earlier in order to execute those trades.” Id. Consequently, users have filed a class-action lawsuit against Robinhood, claiming that the company illegally manipulated the market, while politicians across the aisle—including Senator Ted Cruz (Republican – Texas) and Representative Alexandria Ocasio-Cortez (Democrat – New York)—are bringing congressional attention to the issue. Id.
Short squeezes are common for Wall Street. As Hugh Akston Investments notes, “history doesn’t repeat itself, but it often rhymes.” (Hugh Akston Investments, Seeking Alpha). Notably, in 2008, Volkswagen was heavily shorted but the automotive company’s stock price quickly doubled in value over the month of October. (Simon Moore, Forbes). In 2021 alone, 15 companies—including Bed Bath & Beyond, Moderna, Door Dash, Tesla, and Wayfair—experienced short squeezes, with their stock prices then increasing 198%, 49%, 35%, 22%, and 22% in the month of January, respectively. (Philip van Doorn, MarketWatch). That said, the short squeeze spurred by Reddit is novel because of retail investors’ day-trading activities’ large growth, enabled by Robinhood. (Katherine Burton and Hema Parmar, Bloomberg Quint). This was enough to “turn the old order on its head.” Id. According to two Bloomberg commentators, Melvin Capital’s mistake was leaving traces of their activities in the marketplace: “Reddit users were able to identify stocks that Melvin [Capital] was wagering against and then buy those en masse, unleashing a violent run-up in prices that turned Melvin’s winning bet into a loser.” Id.
GameStop’s long decline and rapid stock inflation raises the question of whether cooperative investing, as seen over Reddit and through Robinhood, should be legal. Robinhood has previously faced criticism for gamifying trading and for creating an investment experience that resembles gambling. (Emily Stewart and Rank Molla, Vox).
If investing is simply a means to squeeze finance elites and other Wall Street institutions, the stock market may suffer long-term complications, such as instability. Many individuals and groups invest in the stock market under the “buy-and-hold” methodology, in an attempt to make a long-term profit, which can fund retirement, education, and other worthy endeavors. (Zaw Thiha Tun, Investopedia). Buying and holding involves choosing an undervalued stock and holding it for an extended period of time, which results in a “safe and steady” profit. Id. Volatility and instability as seen over the past month with GameStop and Robinhood may have a negative effect for retail investors, especially if they are close to retirement.
However, cooperative investing is not inherently bad. Remove the drama of “taking down Wall Street,” individuals can learn from participating in various Reddit groups. Collective investing does not always have damaging motives. If individuals gather online in order to discuss investment strategy, it could have a net-positive effect on the economy. More individuals learning about investing and applying that knowledge to trades can produce profits for the average investor, without necessarily causing a short squeeze. And at the end of the day, each trade inherently carries a risk that the investor may lose part or all of their investment, a risk that every investor, whether a retail trader or institutional trader, must reckon with.