Right now, the whole world is focused on one company: GameStop. It makes sense why it’s grabbed the world’s attention. Everyone’s captivated when they see people on the Internet become millionaires overnight, somehow beating some of the world’s biggest hedge funds. It’s better than watching Luke Skywalker take down the Death Star. We haven’t seen this type of win for an underdog since a 12-year old Bow Wow pump-faked Vince Carter to beat the Toronto Raptors.
GameStop has had a wild week and the story’s not over yet. GameStop stock is still trading at a relatively high price and on forums like r/wallstreetbets, retail investors are encouraging each other to “hold the line” to beat the hedge funds at their own game.
Like all great wars of history, we need to take some time and understand the roots of the conflict to really understand what’s going on. So let’s talk about why GameStop is going to the moon and why Robinhood has taken some huge collateral damage.
The trends that led up to this
Nothing like the current situation with GameStop has ever happened. Judging by what happened this week, hedge funds seemed to think the scenario was as likely as your friend pulling all five pieces of Exodia on the first turn when you’re playing Yu-Gi-Oh with him. It’s important, however, to realize the trends that led to this war have been going on for a long time and only came together just this week.
The democratization of finance
For decades, the stock market was mostly for the old and the already rich. It’s estimated that 84% of stocks are owned by the wealthiest 10% of Americans.
There was a reason why it was hard for the middle and lower classes to get started. If you wanted to buy stocks forty years ago, you’d have to go into a physical brokerage and make trades through a broker, who’d make commissions off of every trade. In addition, it was pretty hard for the average person off the street to understand how to make informed investments and read a company balance sheet.
Those days are done. Nowadays, apps like Robinhood make it easy for any user to get started with zero upfront commissions and a user-friendly interface that anyone could understand. These new platforms have helped to cut the investment gap between whites and African-Americans almost in half.
It’s also easier than ever for stock traders to share tips and tricks with each other instead of needing to rely on a financial advisor. Forums like Reddit’s r/wallstreetbets have millions of users and posters can break down their reasons for buying and selling different stocks. Anyone find the information they need to make informed investment decisions.
A backlash against the elites
Anger at the elites has been building up steadily since the 2008 recession. When the economy crashed, the banks got a bailout from the federal government. Meanwhile, the millions of Americans who were unemployed didn’t find anyone coming to save them.
Feelings of anger and resentment at the upper classes were shared by both the right and the left. Donald Trump got elected president by promising to “drain the swamp” and saying that he wasn’t a “typical politician”. On the Democratic side, Bernie Sanders got more votes and more attention in the presidential primaries than anyone thought a self-declared socialist could ever achieve by promising to fight income inequality.
COVID-19 only amplified the anger people were already feeling. The pandemic has been terrible for poor Americans. The unemployment rate has been as high as 15% and it’s estimated that 12 million Americans are on average $5850 behind on paying rent.
On the other hand, the rich are doing just fine. The capital markets have gotten trillions of dollars from the Federal Reserve, which means the stock market has been hitting new highs even as millions of Americans remain unemployed. Meanwhile, normal people have gotten just $1800 in stimulus checks over the past 10 months.
Sometimes when millions of working-class people are angry enough, they’ll overthrow the government and start sending elites to the gulag like in Russia in 1917. We’re not quite at that stage yet. Instead, retail investors took up the banner of class warfare on Reddit and Robinhood.
u/deepfuckingvalue: The modern-day messiah
It’s hard to believe that this whole thing started from a random post on Reddit. But that’s exactly how it happened. About a year and a half ago, a Redditor named u/deepfuckingvalue (We’ll call him DFV for short) posted a screenshot that showed that he dropped $100,000 on GameStop calls.
It was an incredibly risky trade for a few reasons. Retailers in general are dying because of eCommerce companies like Amazon. The video game industry specifically is starting to trend towards digital downloads. Most people believed that GameStop was headed for bankruptcy.
Just like most other prophets who end up starting a movement, DFV was not well-received by the public at first. Most of the comments essentially called him a clown for betting so much on a struggling company.
For some reason, DFV was unfazed by the initial negative reaction. Wiping the spit of the Pharisees off his face, he kept posting his updates about his GameStop calls.
Eventually, DFV’s posts started getting more attention. GameStop’s stock price went through some wild swings during this time. At one point, the value of DFV’s calls went up to $2 million. For some reason, he didn’t sell. Redditors admired him for his persistence.
The more DFV posted, the more Redditors realized that there was actually a solid case to be optimistic on GameStop stock. Former Chewy CEO Ryan Cohen bought a ton of GameStop shares and pushed the company to close down unprofitable stores and start making moves to win in eCommerce. Plus, a few hedge funds like Melvin Capital had aggressively bet on the failure of the company. All the right conditions for a short squeeze had been set up.
Short squeezes explained
Now is a pretty good time to explain why people short companies. It works like this: If you’re confident that a stock is going to go down, you can make money by shorting it.
Let’s say there’s a stock that’s worth $5 that you’re sure is going to go down to $1. What can you do is borrow 500 shares in this company and then immediately sell them off. If you’re right and the price does go down to $1, you can then buy back those 500 shares and return them. You should come out with $2400 in profit.
Of course, shorting comes with a huge risk. If the price of the stock goes up, you’re going to lose money because you’ll need to buy it back at a higher price. Big increases in stock prices mean huge losses. If you short a stock that’s originally $5 and then it goes up to $700 - you’re pretty much fucked.
If a lot of people have a short position on a stock and they see the price increasing rapidly, they might try to quickly buy back shares so they can return them and limit their losses. If many short-sellers do this at the same time, they’ll push up the stock price even higher. That’s a short squeeze.
Short squeezes are not new - they’ve been going on for centuries. Way back in 1862, Cornelius Vanderbilt cornered the market on Harlem Railroad stock and engineered a short squeeze. What’s different is that now rich dudes like Vanderbilt aren’t the only people who can do this. While an individual trader might not have the type of money that Vanderbilt had, they can do something he couldn’t: Get on forums like r/Wallstreetbets and encourage other traders to make the same bet.
GME to the moon
Earlier this week, Redditors started buying up more and more GameStop stock, which started the short squeeze and started pushing up the price to insane levels. Then, they started to get some help. Famous billionaires like former Facebook executive Chamath Palihapitiya and Tesla CEO Elon Musk both encouraged the short squeeze on Twitter. GameStop’s stock price climbed higher and higher.
Redditors who bought GameStop early were putting up unreal returns. DFV posted an update a few days ago on Reddit. His original position is now valued at $43 million. He’s now pretty much the messiah on r/Wallstreetbets.
But at this point, buying GameStop stock was more than just about making money. It was about fighting a war against the same hedge funds who made all the rules and got all the money while regular people suffered. Retail investors who were betting on GameStop wanted to see the big institutions lose, and that mattered more than just making gains.
It’s important to remember that this narrative of retail investors vs. hedge funds isn’t entirely accurate. There are big institutions on both sides of this trade. One of GameStop’s biggest owners is BlackRock, one of the world’s biggest hedge funds. Still, it’s undeniable that retail investors did real damage to the hedge funds that were short on GameStop.
Seeing what they did with GameStop, r/wallstreetbets decided to ride the hot streak. They found other stocks that had huge short positions like AMC and Blackberry and tried playing the same game. Very quickly, these companies’ stock prices started increasing too.
But on Thursday, something happened that changed everything.
The suits strike back
On Thursday, Robinhood and other trading platforms restricted the trading for 13 different stocks, including GameStop and AMC. Users could no longer buy these stocks - they could only sell them. That same day, GameStop’s stock price tanked.
Since Robinhood at first didn’t make any kind of public statement on why they decided to do this, people speculated that Robinhood was doing a favor for its friends at the hedge funds.
To understand why people drew this conclusion, it’s important to understand how Robinhood makes money. When you buy a stock on Robinhood, the app doesn’t actually execute the trade. It sells the order to a hedge fund that acts as a middleman, executes the orders, and takes a few pennies off of every trade. Over time, the hedge funds make pretty good money off this arrangement. A lawsuit filed by the SEC against Robinhood estimated that this practice cost users $34 million.
A hedge fund called Citadel happens to be Robinhood’s biggest customer when it comes to buying these orders. Citadel also put billions of dollars into Melvin Capital, GameStop’s biggest short seller. If you make the obvious connection here, it’s easy to see why Robinhood users were pissed off.
Is there actually a conspiracy between Robinhood and Citadel?
Robinhood and the other brokerages that restricted trading were met with pretty much universal condemnation for their actions. On Twitter, Congresswoman Alexandria Ocasio-Cortez called what the app did “unacceptable”. For maybe the first time ever, Ted Cruz agreed with her.
Eventually, Robinhood CEO Vlad Tenev had to respond to the beating his app was taking online. He went on every news network that same night to say that there was no collusion and that Robinhood was just trying its best to comply with regulatory requirements.
We don’t have any proof that Citadel or any other hedge fund made a direct request to Robinhood to stop allowing traders to buy GameStop. Still, if Robinhood is telling the truth, they should’ve told users about what they were doing from the start. Plus, they handled it in the worst way possible. If the app restricted trading on the stock entirely instead of only allowing the option to sell, it wouldn’t have looked like Robinhood was artificially trying to bring the stock price down.
I’m not going to make any accusations here, but Robinhood unquestionably fucked up. At best, the app made a really stupid move without properly explaining why it was happening. At worst, it colluded with hedge funds to screw over its own users.
The situation is even worse when you remember that Robinhood has been the preferred platform for young investors and the sorts of people who typically spend time on r/wallstreetbets. In the past, I’ve defended Robinhood by talking about how it’s brought a whole new generation of investors into the market. But now, those same people are incredibly pissed off.
The house always wins
People are expecting GameStop stock to fall back to reasonable levels, but it hasn’t happened yet. While I’m writing this, GameStop stock is still at $325. It’s been estimated that so far, short-sellers have lost $19 billion.
I have no idea how long this is going to go on. What I do know is that the 24 hours when brokers restricted trading of stocks like GameStop gave hedge funds time to close out their original short positions. I want to believe that a bunch of dudes on r/wallstreetbets can win big against giant hedge funds, but all the odds are against them.
It looks like Wall Street is taking steps to ensure that a short squeeze will never be coordinated on forums like Reddit again. NASDAQ CEO Adena Friedman said that in the future, the exchange could restrict trading on stocks that have excessive mentions on social media. Friedman said that the purpose of this move was to avoid “market manipulation”.
This is complete bullshit. In this case, posters on r/wallstreetbets didn’t spread false or misleading information - they just told other Redditors about the moves they were making. A few hedge funds took massive amounts of risk by shorting GameStop stock to an excessive degree - r/wallstreetbets noticed and took advantage. I don’t see how that isn’t just the free market at work.
Meanwhile, hedge funds routinely get away with giving false information to the press just to make a quick buck. If you don’t believe me, check out this video of Jim Cramer breaking down common manipulation tricks by hedge funds.
The fact that the NASDAQ even feels the need to get involved only in this case proves r/wallstreetbets’s point - the game is rigged.
In conclusion
I’ve heard a few people say the stock is going to come crashing down and retail investors are going to be hit the hardest. I’m not sure I agree. The long-term impact of this situation might be a big positive for retail investors.
While Robinhood might have lost the trust of its customers, we can probably all still agree that its mission to “democratize finance” is a good thing. That’s happening more than ever this week. Some of my friends bought stocks for the very first time during the GameStop War. None of them are betting their entire life savings, but many of them are just now starting to pay close attention to the market. r/wallstreetbets even had to go private for a few hours because they were having trouble dealing with all the new members.
I’m really not joking when I say that u/deepfuckingvalue is a messiah. The GameStop War probably will end up bringing hundreds of thousands of new investors into the market, and all it took was a few hedge funds losing a few billion.
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