TBC Explainer: Making Sense of the Redditors vs Wall Street Saga
Here's what happened when a multitude of retail investors on Reddit decided to take on the elites of Wall Street
There is a class war of sorts going on between the fraternity of elite investors in Wall Street, and a group of armchair traders, who congregate on the popular social media platform Reddit. Believe it or not, the group of amateur traders are currently winning.
So, what is the fight all about?
GameStop Corp. that was once a popular videogame offline retailer has been seeing a decline in its sales and value since the mid-2010s. This trend is no news, especially in today's times. When you can find everything you need online, no one is willing to go to a store to buy a video game. But in the hope to boost its sales and transfer to e-commerce, GameStop brought in Ryan Cohen, co-founder of e-commerce company Chewy.
This is when, well-known hedge funds like Melvin Capital and Citron Research, felt that the value of GameStop (GME) stocks was overvalued and they decided to short it.
A quick explainer on shorting—Most of you might be aware of one way of making money through stocks. That is, you buy a stock with the expectation that the stock’s value will rise in the future so that you can sell the stock for a profit. This is called ‘going long’. Now, there is another way to make money on Wall Street. You borrow a company’s stock from a broker and sell it, with the agreement that you will return it back to the broker at a pre-determined point in the future. You wait for the stock’s price to decline to buy it back for a cheaper rate and return to the broker. The profit you made from betting against a company goes into your pocket. This is called 'going short.'
In this case, the 'Wall Street elites' played their move, and were waiting for the value of GME stock to decline. But a group of Redditors had other plans. /r/wallstreetbets is a subreddit where its members discuss trading tips and ideas. These members, a bunch of retail investors, were agitated with how Wall Street institutions with their capital influence were able to bring down the value of GME stocks for their profit. In retaliation, a lot of members of /r/wallstreetbets started buying huge amounts of GME stocks and call options, driving the value of the stock up. In a matter of weeks, shares of GameStop, which closed at under $20 per share on January 12, went up more than 1,600% with a value of $325 as of 30th January.
Now, how did this lead to Wall Street’s big players staring at bankruptcy?
The Redditors forced the hedge funds who betted against GME stocks to ‘short squeeze’. A short squeeze is a phenomenon where the short-sellers rush to buy back the shares before the price rises even higher. This leads to a rise in the demand for the share, effectively driving the price of the share up higher. It’s simple economics –if demand rises, so does the price.
According to data analytics company S3 Partners, Hedge funds and others that betted against GameStop Corp. have mark-to-market losses of $19.75 billion. Hedge fund Melvin Capital told CNBC that it has closed its short position on GameStop after the hedge fund’s backers Citadel and Point72 pumped $2.75 billion into the fund to keep it afloat.
Short-seller Andrew Left of Citron Research told Bloomberg he had covered most of his short position “at a loss of 100 per cent”. This comes after he publicly announced he will be shorting on GameStop’s shares when its value was around $40, which he expected to plunge to $20.
Retail investors or armchair traders took down hedge funds that manage billions of dollars and this has sparked a war of sorts between the amateurs and the elites of Wall Street. Wall Street elites have come forward demanding legal actions against social media users banding together to inflate stock prices while the members of /r/wallstreetbets accuse the former of having made profits in the past at the expense of others.
Why did the stock-trading app Robinhood decide to block retail investors from purchasing more GME stocks?
Robinhood, a stock-trading app, entered the controversy when its users woke up to find that they were unable to purchase 'meme stocks' like GME and AMC. Instead, users who already own 'meme stocks' only have the option to sell it. Its users, who mostly consist of amateur investors, have rallied against the app. They accuse it of turning away from its egalitarian ways to favour the hedge funds and turning its backs on the amateur traders.
“Manipulating the market in favour of Wall St. Completely undemocratic, the exact opposite of their motto,” wrote one reviewer. “Well, steal from the rich and give to the poor, unless you try to take from the rich directly, in which case the app won’t work anymore. Enjoy your hypocrisy,” a user wrote a review on Google Play.
You see, the hedge funds and other short-sellers of GME shares are struggling to buy enough stocks to cover up their losses. At the same time, the amateur investors over at Reddit are also buying these shares and refusing to sell them. This is when Robinhood entered the picture and restricted its users from buying any more GME stocks while the hedge funds can trade them.
This hasn’t gone unnoticed at the White House as US Rep. Alexandria Ocasio-Cortez has called out the app for blocking retail investors from purchasing stock.
Robinhood isn’t the only platform that halted their clients from purchasing shares of 'meme stocks' whose prices rose dramatically after Redditers bought shares and call options en masse.
The company defended itself saying it had decided to limit trades because of “financial requirements, including SEC net capital obligations and clearinghouse deposits.”
"Amid this week’s extraordinary circumstances in the market, we made a tough decision today to temporarily limit buying for certain securities. As a brokerage firm, we have many financial requirements, including SEC net capital obligations and clearinghouse deposits. Some of these requirements fluctuate based on volatility in the markets and can be substantial in the current environment," Robinhood wrote in a blog post. "To be clear, this was a risk-management decision, and was not made on the direction of the market makers we route to."
As the saga continues, no one can predict what is going to happen next. The team of Redditors have made it pretty clear that they will continue bringing down the hedge funds that have shorted other companies. On the other side, Wall Street elites are questioning the ethics and legalities of social media users teaming up to manipulate the stock prices. One thing is for sure though. No one will soon forget about the time when a team of David’s on Reddit used the power of social media to bring down the Goliath’s in Wall Street.