Social media is abuzz with the news of how an army of retail traders through their Reddit community and Robin Hood demeanor have brought down a few hedge funds. Some people are hailing them as heroes while others are protesting the gang mentality of the group. The story is certainly a very interesting event in the history of modern finance and will go down as a case study is finance classes globally. Probably a book and a Hollywood movie are already being conceived on the sheer audacity of the underdogs.
The David(s) have finally brought down the Goliath(s) in real life, and everyone loves an underdog victory.
For those unaware of the events lets me sum it up.
On one side are the retail investors. Call it the lockdown boredom or youtube inspired wealth creation stories, retail investors have flocked to the stock market in a frenzy. Trading platforms like Robin Hood (nomenclature is of immense importance in this story) which provide negligible cost trading facilities and video game kind digital UX interface have been the tools in this frenzy. For some equity trading has become a legalized casino and the thrill and addiction of gambling has been well supported by the liquidity rush from the US Fed and a once in life-time bull run.
On the other side are institutional players, like hedge funds, who are often dubbed to have more money than God. The finest brains of our generation are employed by these finance goliaths and they fight for cents and milli-seconds to beat each other and win. They know that their sophisticated trading strategies supported by leverage gives them a money muscle that no retail investor can dream off. Without doubt their ability to generate billions from thin air is both aspired and envied by all. Social and economic inequality only adds to the envy of those outside this elite finance brotherhood.
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The third character in this story is ‘Reddit’ which is a social media platform based on community networks and associations. Reddit allows users to form communities and discuss topics of relevance to this particular community. There are very many communities on finance but a community called WALLSTREETBETS gets to be the protagonist in this story.
WALLSTREETBETS is an investor community that discusses trading ideas and has about 4 million members. At some point, someone in the community probably realized that if the community could unite and synchronize their ‘buy’ or ‘sell’ orders they could have immense impact on the market and actually move the market. A privilege reserved for the institutional players till now.
This brainwave by an unknown unknown sets the stage for the David Vs Goliath battle.
The financial game starts, ironically with a company called GAMESTOP!
The WALLSTREETBETS community soon realized that hedge funds were holding big ‘shorts’ i.e. betting on the fall in price of a video game retailer company GAMESTOP. Now, ‘shorting’ is a financial transaction in which you borrow shares today with an obligation to return the shares in the future. You hope that the price will fall in the future so that you can buy it at a cheaper rate and return it to the lender of the share. The difference is yours to keep.
The WALLSTREETBETS community figured out that a united buy order flow from them would result in the share prices of GAMESTOP rising. This would expose and neutralize the most vital flanks of the hedge fund masters who were sitting on large short positions since, the problem with ‘shorting’ is that your profits are limited but your loss can be infinite as the price of a share can technically keep rising to infinity. So, when the price of a short begins to increase, i.e., move against you, the pressure starts to mount and the ‘borrower’, in this case the hedge funds, has no option but to buy the shares at a higher price.IN addition to this mental pressure, a sudden rise in prices also activates algorithm-based trading platforms which then have their own automatic orders to follow.
Usually shorting is a good money-making idea because money is a finite resource and the buyers (Bulls) will definitely run out of ammunition (money) at some point (market will top). Thereafter gravity gets to do its job ( Price starts falling) and the short holders (Bears) are able to feast on the panic. At least, this is what the rule of the game is.
Unexpectedly the Robin hood Army equipped with the Reddit cavalry (wallstreetbets) supported by the historical gush of liquidity by the Federal reserve proved to be an unfathomable source of money. Napoleon (Hedge Funds) finally met Wellington (retail investors) at Waterloo (GAMESTOP) !
As the price of GAMESTOP started to rise because of the Reddit ‘Buys’, the hedge funds also had to begin buying to return their borrowed shares, this pushed the prices further. The more WALLSTREETBETS bought, the more the HEDGE FUNDS had to buy. And before they could realize, the hedge funds were scrambling to buy GAMESTOP shares, resulting in the dreaded nightmare called ‘Short squeeze’ (A financial term used to describe panic buying by short sellers to return their borrowed shares)!
The hunters had been hunted.
And this process did not stop with GameStop. Shares of companies like AMD, NOKIA and even Tesla seem to have followed the same trajectory. Commodities like Natural Gas and Silver too were targeted.
So not one, but multiple battles have been won by the Robin Hood army. The losses incurred by hedge funds have run into billions and bankrupted both their bank balances and ego. Truth is no one had ever imagined that unity among retail investor was possible. Since ages, the financial media industry and the so called ‘market experts’ have been powerful weapons of divide and rule for the finance industry. It is not uncommon to see some experts say ‘buy’ and another expert reason a ‘sell’ on the same stock. This has kept the retail investors power remains divided. But the reddit social media movement changed the rules dramatically. Synchronized hundred-dollar orders attained tsunami like power. For some this has been more powerful than the occupy wall street movement, as it has directly hurt were it matters – Monetary Loss.
The regulatory authorities have now stepped in and have banned some aspects of this finance game. Un-neutral umpiring some say but some very relevant battles have been won by the underdogs.
It is without doubt that the financial institutions had been caught unaware this time, but will hereafter infiltrate social media communities and monitor them to their advantage. It is therefore important for retail investors to beware and not try the same tricks again, as ultimately, reddit communities may become ponzi schemes where the initiators of a trade may initiate and entice towards a trade but square-off their positions before others. And get to keep all the spoils of the efforts of the community. The steep fall in the price of GAMESTOP since the public disclosure of the retail investor strategy only proves that the late retail participants have been left holding the baby. Also retail investor must acknowledge that even though it is proud movement for them, not all retail investors are same. Some retail investors follow hedge fund grade sophisticated trading and risk management strategies and therefore are more well equipped at executing trades. So, don’t follow the leader blindly.
Lastly, investing and trading is a money matter, and it is our duty towards ourselves to be careful on its utilization. Wrong and impulsive decisions can be injurious to your wealth building plan in life and have an adverse effect on your happiness quotient in life.
Afterall, money is an important component of happiness!
The author is the author of the bestselling book, The Billionaire and The Monk, available on Amazon (click here to order).
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