January 27, 2021 - 6:27pm
During the past year, the chaotic forces of the digital revolution have broken into the world of finance, in the form of trading apps that allow ordinary punters free access to the stock market. These tools have given rise to social media communities where amateur traders exchange advice and, it now seems, organise to stick a finger in the eye of Wall Street.
The case of GameStop is the latest — and most stunning — example of this trend. Late last year, a confrontation developed between small traders and major Wall Street investors like Melvin Capital Management. As the former rushed in to buy what they viewed as undervalued GameStop shares, the latter saw it as a chance to adopt a short position, which means betting that GameStop’s share price would crash. But shorting is a risky strategy, since if the share price were in fact to keep rising, those betting against it would have to pay the difference.
And so the small investors, led by firebrands on the subreddit WallStreetBets, smelled blood. They continued driving up the price of GameStop shares in the hope of bankrupting the institutional investors. At the time of writing, the shares were hovering around the $300 mark — an increase of 1,400 per cent since January 12th. This week they have near-doubled on a daily basis.
According to Bloomberg, one in five stock trades are now made by such “retail investors,” as opposed to institutional investors such as hedge funds and insurance companies. As this army of new investors has gathered en masse in online chatrooms, notably Reddit and Stocktwits, it has produced strange effects in the markets. It’s no longer unusual to see the market value of small, obscure companies suddenly going through the roof thanks to co-ordinated speculation by amateur traders.
The WallStreetBets subreddit has become the centre of an intoxicating underdog narrative, a classic American romance of the little guy standing up to the corrupt and complacent system. “Hedge fund managers live in the past, and continue to look down upon the retail investors,” writes one influential user, “We can think and make decisions for ourselves, which scares the FUCK out of old school institutions and hedge funds.” Another posted a now-viral message to CNN, complaining that the news network was in cahoots with the institutional investors.
Of course, this is clearly a bubble of some kind, but it is also an a Hollywoodesque tale of plucky outsiders taking on the establishment — indeed, the guerrilla investors turned their attention to GameStop after learning that Michael Bury, the maverick trader immortalised in The Big Short, had invested in the company.
Whatever the outcome though, this episode has provided another striking illustration of how social media empowers the anti-establishment strain in American culture, and turns defiance of the powers-that-be into a source of shared purpose. America has entered a new era in which narratives generated on social media have become a profoundly destabilising force, as we witnessed when Donald Trump’s elaborately outfitted supporters stormed the Washington Capitol at the start of this year. The GameStop saga isn’t an exact parallel, but is also a force for disruption. A deep-seated suspicion of authority combined with technology that empowers self-proclaimed rebels against the system is proving to be a potent cocktail.
Wessie du Toit writes about culture, design and ideas. His Substack is The Pathos of Things.
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SubscribeThe Wall Street vultures overstretched themselves by overshorting the stock trying to drive the business into the ground trying to profit by crashing the share price. A group of investors on the internet noticed, and realised they could cash in on the investors’ greed and stupidity with almost no downside and enormous potential for profit due to the recklessness of the hedge fund. Free money available. And also fun popping a hedge fund’s hubris.
“almost no downside”?
This is a classic pump and dump strategy using social media to pull in the patsy with some additional leverage through options trading. Yes, like most bubbles, if you got in early you made a lot of money from the losses of the people following you.
If you go in now you face large large risks – the ‘no downside’ window has long passed. Once the positions eventually close the price will drop – could keep going up beforehand, but as a bet its getting riskier and riskier.
The “almost no downside” was for those who spotted the opportunity at the outset and talked about it on Reddit. Rich and greedy investment companies had created a practical no-lose situation – their error, not the small scale investors who spotted it.
And it works due to a buy and hold strategy. If the shares return to the market, the short can be closed and the price goes down.
I can’t share the romantic sentiments that some have about this.
It seems to me that what the Reddit investors have done is create a kind of Ponzi scheme, whether intentionally or not. Investors who bought in early might make a profit but those who piled on later won’t be able to sell these grossly overvalued shares at anything but a loss.
Yes they’ve given the Hedge funds a bloody nose but the majority of the retail investors are likely to have been little more than the cannon fodder in this battle.
I’d recommend reading up on what a ‘short squeeze’ is. It’s not about buying cheap to sell to patsies coming in later buying on the trend, which would be a pump-and-dump, or a Ponzi scheme, which is using later investors money to pay off early investors.
The hedge funds took a bet on the share price going down. To do this they play a ‘short’ – they sell a stock they ‘borrow’ but don’t own, planning to repay the borrowed shares by purchasing it at a later time thinking the price will be lower. And if they ‘sell’ big enough, the market also reads it as a signal and the price should go down
This is, of course, dubious financial manipulation and risky. Once the short is played the investor has to buy to close their position. If the stock goes up instead of down, the investor has to purchase at the higher price to cover the ‘borrow’, and they lose money. Potentially lots and lots of money – it’s not limited to their original stake – because they have to pay for the ‘borrow’ in the end at whatever price that reaches.
Small time investors had noticed that more than 100% of the stock was shorted. That meant, there weren’t enough shares in the market to cover investors positions. Anyone holding stock would therefore expect the price to rise as the investors returned to buy back their ‘borrowed’ shares. Not only that, but because there weren’t enough shares to go around, demand would massively outstrip supply.
And, if the stockholders were to hold the shares instead of selling them, they would exacerbate the share shortage and the price would rocket – which is what has and is happening.
So the investors have an obligation to buy shares to cover their short, but there are no shares to be bought – hence the massive increase in price. This is the essence of a short squeeze. If the investors had borrowed the share at $3 (low point), they now have to buy back shares at hundreds of dollars each (so each $100 of short could end up costing $20,000 for buy-back). That’s how they are losing several billions of dollars on this.
So it’s not taking other small investors here like the Wall Street sharks would do. The pros made a big mistake that the amateurs noticed. It’s the pros having their feet held to the fire for greedily overshorting the stock.
I’m aware of all that. Closing the short position does account for part of the rise in the share price but it doesn’t change the fact that there are retail investors now who’ll have bought at the top and now won’t be able to sell at anything but a loss; unless it’s to another naive investor who will take the loss instead of them.
The shares are massively overvalued, which hurts the Hedge fund who were forced to buy but also any investor who came in too late not understanding what was going on. They’re the collateral damage in this crusade.
The maximum a small investor can lose is their stake. Buy a share at $100, and they can lose all of it – maybe thousands of dollars. The loss for the hedge funds is going to be many many multiples of their stake due to the short – billions of dollars.
Individual investors are not the driver of the price and, as far as I saw this morning, the short position is still open. If a retail investor is buying shares for themselves and doesn’t know the risk at this stage, given all the publicity, they shouldn’t be buying and selling shares on their own. No-one is buying based on inherent value.
Thank you for this elucidation. But if there are still Hedge funds needing to buy shares, how can the small investor lose? Why would the price ever go down during this spectacular squeeze?
The price will drop suddenly once the short position is closed. In other words when the hedge funds have settled their obligations, demand will collapse, potentially creating big loses for any chancers buying at the top of the market.
However, somewhat bizarrely, this in itself can also encourage a second tranche of short sellers into the market. If a short seller enters now at $250 expecting the price to drop back to $15-20 once the first hedge funds have been cleaned out, it can then exacerbate the rising share price. The whole thing gets riskier and riskier until all the short positions are closed. It’s a game of brinkmanship – the potential for risk-free money, that the early players had, is long gone.
I think I now understand
Yes, I’ve been following this one on the Louis Rossman and Tim Pool podcasts. A great story, for the moment, but evil will probably win eventually, as it always seems to do.
Indeed. Billionaire Steve Cohen has just invested $2bn in billionaire Plotkin’s struggling hedge fund….they have a lot more ammo.
I think of tulips…
and the madness of crowds, to coin a phrase
These traders are not “rebels”.
They’re using a quirk of the options market to manipulate share prices. This has absolutely nothing to do with the underlying value of the company, whether good or bad.
The end result is that it becomes riskier to be an options dealer, the general price of buying options rises, and the banks make even more money.
No it isn’t – the BBC took on your “sticking it to the man” narrative this morning with the following headline
” GameStop: Amateur investors continue to outwit Wall Street’
Share price is down 65% already.
Social media fads/manipulations (and brainless national broadcasters) continue to cost the “less bright” their money and prospects.
Generally an interesting article, and whilst not fully understanding
the mechanism of the stock shorting, the readers comments below have
provided some illumination. However the author is looking through the
wrong end of the telescope by comparing the Trump rally with the new
era of social media as a profoundly destabilising force. The Barons
of Media have seen to that by the careful curation of what truth is
allowed to propagate on their platforms. I think that the future will
hold less scope for the Robin Hoods and more control for the Robber
Barons.
The Final Melt-up. Think of the point at which the markets are at the most insane, extreme, and cannot possibly go higher. Double it. Then wait six months while Jason’s decomposing corpse attacks various Bear parties, killing them all. Then, …., wait for it, wait for it, … you get …
*another* vertical ramp upwards(!!)
Then it crashes.
And poof! Value just disappears. Trillions in value destruction. And two decades to finally draw back level.
It would be interesting to see what percentage of Game stop shares are actually held by these small investors. My guess would be they hold a minority share say 10% maximum. It can’t be just these investors forcing the price up, other investors with much larger holdings must also be holding onto stock in the face of this current and pent up demand. Pent up, because all the shareholders will be aware now that certain Hedge Funds have to buy these shares at some point to satisfy their short options. As I understand it at one point the short options were 140% of the total number of shares, so there is massive future demand built into this share. I think many of the short options mature today. I have a question : what happens if the Hedge Funds can’t meet their obligations re their position. I. e. they sold 10m shares 2 weeks ago that they didn’t have, and they need to obtain them now,. What if 10m shares aren’t for sale, or the price is now so high they don’t have the funds to pay it?
Maybe it was Wall Street types on the other side of the Game Stop episode? How many day traders have millions or hundreds of millions just to prove a point, just like here, who really knows who’s on the message boards and you end up in a position where only establishment figures can invest. A bit like the manufactured Capitol building protest which the Police made no effort to stop.