After the shitstorm of a year that 2020 was, we all hoped that things would go more or less back to normal in 2021. However, one area where the chaos of 2020 seems to have spilled into 2021 is on Wall Street.
Unless you’ve been living under a rock, you’ve definitely heard something about GameStop stock prices going to the moon, and how hedge funds, the SEC, and pretty much everyone else involved with investing is freaking out because of it.
How did this all come to be? Reddit. That’s right, the online forum site that used to be for cat memes and discussions about online RPG games just rocked the world of Wall Street. If you’re not totally sure what exactly happened with the GameStop boom, don’t worry, I’m going to lay all that out for you in this article. And I’m also going to talk about 5 ways that Reddit has changed the world of investing forever.
Reddit vs. Wall Street
This saga all starts on a subreddit called WallStreetBets. This community discusses investing news, talks about the best new investment opportunities, and is notorious for praising investments whether they gain or lose money, as long as they’re bold as f**k.
One of the main influencers in the subreddit is a guy named Keith Gill. Keith realized that he could use his influence in the subreddit to play Robinhood, and I’m talking about the storybook hero from the Sherwood forest, not the app.
You see, Keith noticed that a ton of hedge funds were taking short positions on GameStop. Now, let me just clear a few things up. Hedge funds are very large investment funds, the institutional investors that many consider to be the “fat cats” of Wall Street. A short position is basically a way of betting that a stock’s price will go down. If the price goes down, the short seller gets money. With the decline of brick-and-mortar retail companies like GameStop in recent years due to the rise of ecommerce, tons of hedge funds have been taking short positions on GameStop.
Alright, so what did Keith Gill do? He took to the WallStreetBets subreddit and convinced other Redditors to buy up as much Gamestop stock as they could to drive up the price. What was the point? To stick it to the man, and make those fat cat hedge funds lose a bunch of money on their short positions.
To add another layer to this, Gill was trying to induce what’s called a “short squeeze”. That’s when short sellers want to get out of their bet, and so they’re forced to buy the stock that they originally shorted. This has a compounding effect because it will drive the price of that stock up even further, which is exactly what happened with GameStop.
This little Reddit grassroots revolution was made up of individual investors, many of who are trading through Robinhood (I’m talking about the app this time) or other similar platforms. The point of this demonstration was to punish the short selling institutional investors, many of who have profited from the economic downturn from the pandemic that the rest of us have suffered from.
So, did it work? Yeah! GameStop’s stock price started at around $17 at the beginning of 2021 and went to about $347 near the end of January. That’s an increase of nearly 2,000%! It got so out of hand that Robinhood and other trading platforms had to put a stop on all trades of GME. The price then began to drop back down again, only to experience another rise in early March.
As stock prices usually follow a company’s profits, GameStop’s price is expected to fall back down around $15 per share eventually, but it will be interesting to see how long this so-called “Reddit effect” will keep it inflated.
One thing that hasn’t changed: GameStop is still in trouble, as their sales have been in steady decline with the slow death of brick-and-mortar. But while these Robinhood investors (this time I’m using Robinhood in both senses) may not be able to save Gamestop, let’s look at 5 ways that they may have changed the investing landscape forever.
#1: Greater Interest in Stock Trading
While hedge funds and other institutional investors definitely took a hit from the GameStop boom, they might actually benefit from this entire ordeal. As I said at the very beginning of this article, the only way you haven’t heard about this situation is if you’ve been living under a rock. The words “Wall Street” have been all over headlines this year, and what does that mean? More normal people are thinking about the stock market.
This whole Reddit fiasco shows that investing doesn’t have to be only for the big wigs on Wall Street, but for the average person as well. And that means that in the future, there’s going to be a large flow of investment capital going into the market.
Who profits from increased capital flowing into the markets? You guessed it. Those hedge fund fat cats.
#2: Investing Models Need to Factor in Reddit Risk
Is GameStop the only company that experienced such a massive surge in their stock price this year? Other soon-to-be-dead companies like Blackberry and American Airlines have experienced similar upswings, which means that what happened to GameStop might not be just a one-off event, but a new trend that could affect markets in years to come.
Like I said, even after GameStop’s price started falling from its peak, it just recently experienced another surge, which means the Reddit effect has some sort of persistence. Institutional investors can’t just sit back and ignore this as a passing fad anymore. They’re going to have to start factoring it into their investment models.
Of course, they’ll keep forecasting using the traditional methods of fundamental and technical analysis, but they’re also going to have to consider the risk that a Reddit-fueled surge might occur, particularly to companies that they’re looking at short selling.
Before a hedge fund takes a short position on a stock, they’re now going to have to consider, might the Redditors artificially drive the price up on this one?
#3: Short Selling Gets a Bad Name
Many have complained about short selling for a long time. Most notably, Elon Musk came out and called short selling “a scam legal only for vestigial reasons.” Basically, the Tesla CEO thinks it should be banned. Many already think that short selling should be illegal because it’s immoral to profit on failing companies, especially because if enough people short sell a stock, it may artificially drive the price down.
Short selling has also historically been a trading tool only available to very large investors; however, it has become more accessible to the average person in recent times. This also presents a problem, though, as short selling can be extremely risky, since potential losses are essentially unlimited.
Imagine that you short a stock and it ends up increasing in price by infinity percent. That’s an infinity percent loss right there. So, it’s likely that after this whole GameStop situation, many investors will start to stay away from short selling more.
However, that might also not be a great thing since many experts, including Warren Buffet, say that short selling can be beneficial for markets by making sure that market capital gets put in the right place and for preventing financial bubbles.
#4: Bad Companies Will Get a Pass
To piggyback on the last point I made, short selling is an effective way of punishing companies for poor practices or fraud, and the fact that investors are going to increasingly shy away from short selling means that many of these not-so-great companies are going to avoid that punishment.
You can think of short sellers as sort of the police officers of Wall Street. If a company is doing something fraudulent, or not using their money in an effective way, short sellers will make sure that their stock prices go down.
Then, other investors start pulling their money out of that stock and putting it into a better stock. In that way, short sellers are making sure that our financial markets, and our economy as a whole, are functioning as efficiently as possible. Without these so-called police officers, poor companies would be free to do whatever they want with little to no effect on their stock prices.
#5: The SEC Will Be Watching
Don’t think that the SEC hasn’t noticed what’s going on here. They’ve been keeping a watchful eye on the entire situation, and will continue to do so, searching for the slightest whiff of foul play. Politicians on both sides of the aisle have criticized Robinhood for stopping buy orders of GameStop, saying that it’s unfair for them to stop average people from doing what hedge funds do all the time, which is intentionally drive prices in one direction or the other.
Hopefully, out of all of this, the SEC will be able to come up with a set of regulations that will make institutional investments more transparent and accessible to the average person, and this them-versus-us attitude that these rogue Redditors have can go away.
It’s time for the SEC to take a long, hard look at Robinhood, institutional investors, the Reddit effect, and the market as a whole, and figure out what the hell to do about all this.