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The battle of Wall street and Reddit: An inspiring story and what you need to know
Fevereiro 15, 2021

How it started and what happened

There was undoubtedly a deluge of news in the previous weeks about Gamestop(GME), the so-called ’Wallstreetbets’ Reddit group, the stock market, hedge funds, and trading apps.

Will this Reddit army, which crashed Wall street be able to change the future of investing? Nobody can say for sure. What we can argue on at least, is that the game has changed and will never be the same again.

It all begun with a group of amateur day traders that started a battle with a bunch of Wall street professional investors known as short-sellers. According to the former president of Federal Reserve, Richard Fisher “They have seen the rich get extremely rich by taking advantage of cheap money, and they want to get their piece as well”

Wallstreetbets community, a group on Reddit with more that 5 million followers, decided to perform actions that will force the short-sellers of Wall street-mostly hedge funds to abandon bearish bets against struggling companies such as AMC and Gamestop, and at the same time, to drive the stock prices up so they can secure profits for themselves.

Therefore, Reddit investors began piling up on Gamestop, a retail store in the United states that sells mostly used video games and has been heavily shorted by hedge funds, which have also released reports explaining why it is a bad stock and the rationality in which they based their decision on.

WallStreetBets members and other investors decided to buy call options of these stocks. Those who sold the call options had to buy shares of the underlying assets in order to hedge their risk exposure. Moreover, the particular hedge funds who shorted the stocks, have also to buy the underlying asset for hedging purposes. As a result, these actions pushed the price of the aforementioned stocks to the moon and the short-sellers were losing billions of dollars.

The consensus on Wall Street seemed to be that GameStop is a retail store, and we all know how retail stores have been hammered during the pandemic, but also, they believed that it operates in a declining industry and it soon will go the way of Blockbuster.

Concerns

If we examine the case of Gamestop, the stock price was up 1,587% since the beginning of January. What raises concerns is that the extreme surge of the price was not based on any fundamentals and had little or nothing to do with the Company’s strength as a business.

A review on the financial statements of those companies would indicate that there is no rationality or any factor supporting their price surge as those companies are loss making for a long period now and nothing would support that Redditors decided to invest in those companies because they believe in their potential.

While the hedge funds were greedy in their mad rush to capitalize on the expected declines of these troubled stocks, their opinion of the long-term prospects for these companies wasn’t far from the mark.

More than any other time before, the market is unexpected and irrational. The efficient market hypothesis is no longer valid as the share prices do not reflect all available information. When people are piling into stocks based on FOMO(Fear of missing out) and do not take into account the fundamentals, since none of those companies have the fundamentals to support such sky-high prices, we can conclude that the stock market is now riskier and investors should be in a position to face the unexpected.

Many celebrities and influential people like the CEO of Tesla, Elon Musk and Mia Khalifa took part in the game and pushed the prices of Gamestop, Blackberry, AMC, Dogecoin and silver even higher, showing-off the power of social media and influencers as well as the impact it can have in the stock market.

How brokers reacted

One of United states most popular trading app for retail investors, Robinhood, decided to crash the party. Due to the extreme volatility, Robinhood suspended trading of the red-hot Reddit darlings. As a result, the Wallstreetbets crowd were left with only two options: to hold their positions or sell them.

The brokers curbed trading in stocks such as GME, AMC and Blackberry because as they claim, they wanted to protect their customers.

On the other hand, hedge funds and institutional investors were able to carry on and continue trading the stocks. Therefore, it was a matter of time for Gamestop(GME) to lose a significant percentage of it’s early profit in just a couple of hours. Robinhood users were furious and started giving negative feedback to the app in order to force them to recall their trading restrictions.

A Robinhood customer filed a class action lawsuit against the trading app in Federal court, claiming that they completely blocked retail investors from purchasing Gamestop, for no legitimate reason.

Initially, Robinhood limited purchases to one share per user, then gradually loosened the restrictions to allow for more shares. By late Thursday, the restrictions were completely lifted.

The end of the trading limits came after Treasury Secretary Janet Yellen met with federal regulators Thursday over market volatility stemming from GameStop stock and the other short squeezes.

The consensus on social media seemed to be that Robinhood, which built its brand on “democratizing” investing, appeared to be caving to pressure from powerful institutions on Wall Street.

The Securities and Exchange Commission, the agency that regulates Wall Street, said it will “closely review” actions by trading platforms to restrict transactions.

The Securities and Exchange Commission is also examining how brokerages handled increased trading volumes during the January tumult and firms’ decisions to restrict buying of GameStop and other stocks. The regulator is looking into whether brokerages complied with rules and were consistent in how they made disclosures to their clients.

by Styliana Charalambous
Head of Market Research