On the rabid social investing phenomenon and the challenge to the status quo — 22ndStreet Blog
Robinhood is a free trading platform that allows retail investors to buy stocks and options. This Thursday, Robinhood stopped supporting the purchase of stocks of the following companies — GameStop, AMC and Nokia, without providing any information on how long the halt would last.
It might seem strange for a trading platform to stop supporting the purchase of only a few selected stocks. However, Robinhood might have a good reason to do so. Do note that the reason might be good for Robinhood but is a gigantic middle-finger to their customers, the retail investors.
A modern David and Goliath story that doesn’t really concern GameStop at all…
You’re a firm who makes money off of exploiting a company and manipulating markets and media to your advantage,” the poster writes to Melvin Capital, the most prominent of the GameStop short-selling hedge funds. “I dumped my savings into GME [GameStop’s trading symbol], paid my rent for this month with my credit card, and dumped my rent money into more GME. This is personal for me, and millions of others. I’m making this as painful as I can for you.
GameStop is an American company that operates brick-and-mortar stores that mainly sell video games and consumer electronics. With increasing competition from digital sales, the company has been in decline over the last few years. The pandemic meant further loses to their business that’s primarily based on their physical locations.
Since the price of the GME stock was dropping, many institutional players like Melvin Capital had started “shorting” the stock, expecting to make profits as the price went to the ground.
“Shorting” a stock basically means you’re betting on the price of the stock going down. In order to short a stock, you borrow the shares at current prices and immediately sell them. When the price of the stock goes down, you rebuy the shares and return them to the lender, keeping the profit for yourself.
According to CNBC, GME was “the most shorted stock” in the market. Since it was shorted so much by institutional players, it was an ideal target for a “short squeeze”.
At this point, let’s clarify that the Goliath in this story represents the institutional players, the ones who were shorting the stock. Remember they did not buy the shares but instead borrowed them and sold them. They were planning to buy back the shares once the price went down.
However, if the price did not go down and instead kept rising, they would still be obligated to buy the shares to return them to the lender.
Since there’s no upper limit to how high the price can go, there’s no limit for the loses you would suffer buying the shares too. Also when you buy the shares to pay back the lender, you will drive up the price of the stock. The people on the other side, who bought the shares when it was being shorted, would see their holdings grow exponentially.
And that’s where the David of this story comes into play and their slingshot was the “short squeeze”.
/r/wallstreetbets (WSB) is a subreddit that has been infamous for a long time now. With more than 4 million members, the message board is home to aggressive trading strategies which are highly speculative. Referring to themselves as “autistic” and “degenerates”, the community position itself as a joke with many members pumping money into “meme” stocks. The use of easy-to-use and no-commission mobile brokers like Robinhood is rampant in the community.
On 22nd January 2021, WSB pulled a “short squeeze” on the GME stock, driving the price of the share up by 700% in a few days.
As we covered, the exponential rise in the price corresponds to an exponential rise in the losses of the hedge funds that shorted the stock. Additionally, since WSB was buying options instead of stocks, the market-makers and lenders had to buy additional shares to provide liquidity which resulted in the price of the GME stock rising even more.
Because of the “short squeeze”, the hedge funds shorting the stock lost a ton of value. Melvin Capital, one of the most prominent funds shorting the stock lost 30% of its value by 28th January 2021. Another hedge fund, Citron Research, had to close their position at a 100% loss.
Naturally, some big players also made money off the squeeze. BlackRock Inc, a huge investment firm holding approximately 13% of GameStop’s shares stands to make potential gains of 2.4 billion dollars.
It seemed like David had won this one but unfortunately, we also learned that the game had been rigged for Goliath as Robinhood and a number of other traders halted trading of GME and a few other stocks that WSB was targeting in order to prevent further short squeezes. Some trading platforms are allowing people to sell these shares but prohibit them from buying.
Robinhood or Robbing the hood?
Along with a few other exchanges, Robinhood decided to halt the buying of shares popular with the WSB crowd. This met by a severe backlash and a lawsuit has been filed against Robinhood so far. According to Robinhood, the decision was taken to protect the retail investors and since they could not comply with financial requirements like SEC net capital obligations and clearinghouse deposits and had to halt the buying of the shares.
This would not be the first time Robinhood has faced criticism for its operating methods. Previously, the company was fined 65 million dollars by the SEC for misleading statements on how it made money.
The company doesn’t charge a commission for trades but instead makes money by selling the retail trading data to investment firms like Citadel Securities. This is controversial since the investment firms can “front-run” the orders, essentially using the data to be a step ahead of the retail investors.
After the ban on buying these shares, the prices started falling.
GameStop was down more than 60% by lunchtime on Wall Street, while the share prices of other companies caught up in the affair, such as Nokia, BlackBerry and AMC, also suffered big falls. All four companies are among a small group that have soared in value due to a phenomenon that began on the web forum Reddit, where users took aim at hedge funds making big bets against GameStop.
The rabid social investing phenomenon
WSB is not the problem but a symptom. Ever since the financial crisis in 2008, there has been a spike in the hatred against Wall Street elites, most notably with the Occupy Wall Street movement in 2011.
Ten years later, we’re living through a pandemic and consumer spending has been at an all-time low.
With more time and money in their hands, a group of people organized to destroy Wall Street at their own game and they succeeded, only to be shut down and suppressed by trading platforms giving the hedge funds an advantage.
With GME, this is not the first time we’re seeing the rabid social investing phenomenon in action, and this will not be the last time. The wheels have just started to spin and we might be in for the ride of our lives in the coming turbulent decades as we rage against the machine.
In other news, Bitcoin also gained in value indicating that people might be looking more keenly towards a decentralized system with a level playing field.