Hi Naaman, my Twitter feed is full of memes about a face-off between Reddit users and hedge fund bros. What’s going on?
Hi Shelley, you and more than $6bn of lost hedge fund money are asking the same question.
You may have noticed that the stock price of GameStop, a struggling US computer games retail company, has soared from US$96.80 to $347.50 in the past three days – a rise of 359%. Or, more impressively, a rise of 10,692% compared to its price of $3.25 in April 2020.
This has nearly bankrupted a few hedge funds, to the delight of smaller investors, mostly organised and egged on by the online forum Reddit.
How we got here is a complex tale – involving class warfare, the mechanics of meme culture and a phenomenon known as a “short squeeze”.
Essentially, retail investors have found a way to use their collective buying power to exploit a weakness in short selling, and both make money and a point in the process.
OK, let’s start with the Redditors.
So, the main character of this tale is a subreddit called r/Wallstreetbets.
Reddit forums trade tips on anything from bodybuilding to relationships and finances, but this one is about risky stock market investments. It’s been around for years – offering a highly variable level of return to its members.
r/Wallstreetbets is marked out by a devil-may-care approach to shares – its users are keen to gamble big and disdainful of traditional traders. It has evolved its own language and in-jokes, with users openly talking about making dumb decisions and the subsequent coin-toss of losses and gains.
But over the past six months, accelerating in the past few weeks, its users have zeroed in one one main stock – GameStop – and a tactic involving the “short squeeze”.
Sounds complicated. What is a short squeeze?
Essentially, on the stock market, you can bet on a share price falling rather than rising, by “borrowing” shares and selling them at the current price, with the obligation to buy them at a later date, at whatever price they have then reached. GameStop, before the frenzy, was one of the most shorted shares on the US market, as a range of funds bet that it would slump during the pandemic.
A short squeeze happens when a stock price that was expected to fall, instead rises. Traders who have shorted the stock now need to buy the stock to fulfil their obligations under the short – which drives the price up even further.
A series of users on the Reddit forum r/Wallstreetbets noticed that GameStop was (a) undervalued by the market and (b) vulnerable to a short squeeze.
A few canny Reddit users began beating the drum, and some legitimate high-profile investors also bought in, such as Ryan Cohen, who founded the online pet food company Chewy, and trader Michael Burry, famous for his portrayal in the book and film The Big Short.
GameStop’s low share price, thanks to the shorters, made it relatively easy for a large number of people to buy in with little money. Some bought in believing in the stock, others because they thought it was funny – GameStop was easily memed thanks to many Reddit users’ fond memories of the chain.
As the share price rose and rose, more people bought in – both to trigger the short squeeze, and because the price itself was now a way to make money.
Got it (kind of). Now why am I seeing the word “stonk” everywhere?
Stonk is essentially just a funny way to say “stock” – and once you understand that, it explains everything else that has happened. The meme itself started circa 2017 with this absurdist, funny cartoon and it has now become the default lingo of r/Wallstreetbets.
— kevin m nye (@kevinmnye1) January 27, 2021
The humour, irony and self-deprecation of r/Wallstreetbets is the engine that powered the initial purchase of GameStop shares.
When Elon Musk tweeted “Gamestonks” and linked to the r/Wallstreetbets forum, the share price jumped about 150% in after-hours trade (although there are suggestions the timing of the rise was a coincidence).
Sounds like this whole thing proves that the stock market is nothing but a fever dream.
Sort of. A lot of people are crowing that this is giving large hedge funds and traders a taste of their own medicine.
These funds have historically been able to shift the price of a stock for their own benefit, whether that is the “pump and dump” (inflating a stock price just to sell it immediately after), or by openly and heavily shorting it.
A lot of sentiment on r/Wallstreetbets celebrates the fact that the rush on GameStop is no different from the dotcom bubble, the property bubble, or strategic drops in the traditional financial media.
Gotta admit it’s really something to see Wall Streeters with a long history of treating our economy as a casino complain about a message board of posters also treating the market as a casino
— Alexandria Ocasio-Cortez (@AOC) January 27, 2021
For others, it is a form of wealth transfer – the only losers in this trade are large hedge funds, and the winners are lower-income internet users, some of whom are only putting up a few thousand dollars. The “live by the sword, die by the sword” attitude to the hedge funds is, in many ways, revenge for the GFC.
If Redditors rallying GameStop is unacceptable market manipulation, what would you call it when greedy Wall Street bankers gambled away our entire economy in 2008 and faced no consequences?
— Robert Reich (@RBReich) January 28, 2021
Damn, actually on the sub rn and it's common sentiment. Just wow pic.twitter.com/uGb8gen2lY
— im a spoon ≥ 🧢🗽🥂 (@Velokx) January 27, 2021
Will this affect other stocks or could it destroy the market?
The same effect is already happening to other stocks, such as AMC, BlackBerry and Nokia.
These share similarities with GameStop: high short percentages, low entry prices and a popularity for cultural, non-financial reasons that make them memeable.
But GameStop was the perfect target, and many of these other stocks are not as shorted nor as popular.
This exact scenario also can’t apply to other stocks that don’t have a significant percentage of short sellers, or that aren’t down in the dumps. For example, Reddit could not coordinate the same thing on Apple shares.
Of course, any hype online or on social media would raise a share’s price, but without the low entry price or the short squeeze, those extreme multiplier factors aren’t there.
But this does look set to change the game of short selling forever, and that will have huge ripple effects. The power of retail traders now seems higher than ever, and social media has been shown to be a remarkably effective method of stock market hype.
Thanks Naaman. It seems like there is some poetic justice at play here.