What if I told you that a bunch of Redditors, yes the online community that is more associated with memes, than financial analysis, battled with experienced and large investment companies and made a profit at their expense. Nobody would’ve believed this a week ago. This is exactly what played out over the last week. What’s surprising about this event is that people as young as 10 years old turned US$60 into more than US$3000. Someone turned their USD50,000 investment into nearly USD50 million. This bunch of Redditors brought down a big hedge fund. The position of that hedge fund got so bad that it had to be bailed out by other investors. This became the biggest financial story because it showed the power that online communities like Redditors can have on financial markets. How did the Redditors manage to pull this off? They bought the stock of a company called GameStop, a retailer of video games and consoles. Not many had hopes for this company. In an era of online retail, not many people would go to a physical store to buy games. Hence, many big hedge funds felt that the stock price of this company would go down. In effect, they had shorted the stock. But the Redditors had something else in their minds. Before we get into this, it is important that we understand what short and short squeeze is. Short is one way to make money in the financial markets. The key condition required to make money here is that you believe a stock's price will drop in the future. Suppose you believe that the price of Baburao & Sons’ stock will go down. You go to a broker and borrow that stock. The broker says that you have to return it in 48 hours. You take this borrowed stock to the stock market. Imagine that the stock price is INR1000. You sell this borrowed share and get INR1000 in return. Then you wait for the price to drop. Once the price drops, you buy the share for INR800 and return it to the broker whom you had borrowed it from. Since you had sold the stock for INR1000 and bought it for INR800, you make a profit of INR200. This works only when things go right and the stock price falls as expected. But when people are already aware of a stock being shorted, they can end up creating a stock squeeze. This can lead to a loss. During a short squeeze, you do the same thing initially. You borrow the share from the broker and then sell it in the stock market for INR1000. Then you wait. But now imagine that there are some people who’ve noticed that you have shorted the stock. They sense an opportunity to earn profit. They start buying Baburao & Sons' shares so that the stock price increases. This is a dangerous sign for you. Because you only have INR1000 and the broker is asking for his share back. So you wait in the hope that the stock price goes back. While you are still waiting, there are others like you who also had shorted the stock. They end up buying the share at INR1,200 to return to the broker and incur a loss of INR200. As everyone who had shorted the stock started buying, the price increased further. So you have no option but to buy it at the price of INR1,600 and incur a loss of INR600. This is exactly what happened in the GameStop saga. Many leading hedge funds had shorted the stock of GameStop. As the Redditors discovered this they bought the GameStop stock and increased its value. Thus the hedge funds were short squeezed. This trend didn't start last week. In fact, it started way back in 2019. This is a YouTuber, who goes by the name, Roaring Kitty. He was one of the early believers in the value of GameStop and believed that its value will rise. He asserted that on the contrary to what the hedge funds believe, the price of the stock will rise. The investors like Roaring Kitty were further encouraged by two stories. First, the news that a co-founder of a big company was investing in GameStop. Second, Michael Bury, who was showcased in the popular movie, The Big Short, also believed that the company is likely to do better in the future. Last year, someone posted on Reddit that GameStop's short-interest was 120% The Redditors saw it as an opportunity to create a "short squeeze" and earn profit. And the circumstances were in their favor as well. First is that the lockdown meant that some young people had time and savings. Second is the lack of other investment options. For example, there was no sports betting. They got a big push by using trading applications like Robinhood, which gave first-time investors wider options to start trading on their own. Robinhood doesn’t charge a fee and the accessible user-experience made it easy for young investors to use the app. It soon became the most downloaded app in the app store and Google Play store. These factors pushed the Reddit community, where the young traders share advice as well as memes. The most famous was the subreddit called r/WallStreetBets. Now small investors, who are usually known as retail investors, typically can't influence a market significantly. Because the market is dominated by big institutional investors, like hedge funds. But RobinHood and Reddit have shown that such retail investors can swing the market. Another reason which moved the Redditors was the encouragement they received from big investors, who they treat no lesser than a "God". Elong Musk, Chamath, and Cathie use social media very effectively. They share complex information about financial investments in easy-to-understand form. Chamath pens a simplified one-page summary of each investment making it more accessible to retail investors. Their enormous popularity among youngsters in turn helps them raise money for their companies. To grasp the power these personalities have on retail investors you can take a look at Elon Musk’s tweet. His one-word tweet - "Gamestonk" increased the stock's value. Recently on his Twitter handle, he added the word Bitcoin to his bio following which Bitcoin saw a spike within a few minutes. The fundamental value of these assets hasn’t changed. What has changed is their perception of people. And Elon Musk has influenced to change the perception with a mere tweet. Now many are claiming that this was a political statement by Redditors to the institutional investors. One Reddit user mentioned that a lot of people in the subreddit lost their jobs during the 2008 crisis. The same rich people that caused the market crash are still in power and manipulate the market to get even richer. One subredditor made a post four months ago titled "Bankrupting Institutional Investors for Dummies". This could’ve been a partial motivation: for the Redditors to show that they can compete with institutional investors. But to say that it was just a political statement might be misguiding. They were there to make money. The political statement was an after-thought rather than a primary motivation. This incident has led to three consequences: First is the allegation that Redditors manipulated the market. This has called for regulatory scrutiny. Many believe that similar speculation was seen during the dot-com bubble during the early 2000s when a group of people hyped the value of a stock, leading to a crash. The counterargument here is that the stock market is all about manipulation. The second is the Robinhood app. Robinhood kick-started with the objective of making trading more accessible. Many believe that the app has made trading overly-accessible, which can lead to risky investments by youngsters. The common argument against Robinhood is that the app has turned trading into a game, making it addictive to people. When you sign up, it offers you a free stock, displays celebrating emoticons once you trade the stock and gives you rewards familiar in games. The counterargument suggests that the backlash against Robinhood by retail investors is an example of elitism. For decades, trading has been dominated by Wall Street given that it requires a lot of money. Independent investors had little money and lacked the institutional access required for trading. But Robinhood has changed that. This competition has prompted institutional investors to speak against apps such as Robinhood. The third issue being highlighted is the nature of the online community. The Internet has two powers. First, it can mobilize a large number of people. Second, it can mobilize them in a short period of time. This way the online communities can gain a lot of influence be it for a trivial or serious matter. The online communities pressed for Sonic the Hedgehog’s graphics to be changed and ensured that Trump's rallies receive low footfalls. Though it can create a positive change, many fear that the community may start to act like an “online mob”. And we can say for sure that the GameStop saga won’t be the last incident. Hi guys, I hope you liked the video. I referred to several articles and videos while researching this issue. I tried to simplify it for the viewers. So, I hope you liked it. If you’re wondering if something of this sort can take place in India. Well, it can’t because of the regulatory restrictions. I won’t go into details but there’s a regulation called Market-wide Position Limit that controls such risk-taking behaviors. So, thank you for watching and see you next time.
