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What you need to know about Reddit, GameStop and the chaos on Wall St

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David and Goliath have found a new arena of battle: the US markets.

This week, members of the aptly named Reddit forum r/WallStreetBets stuck it to hedge fund Melvin Capital by feverishly buying up shares in GameStop (NYSE: GME), a stock the hedge fund was short on.

WallStreetBets members pride themselves on being the antithesis of professional investors. As self-proclaimed autists and YOLO (you only live once) traders, they shoot from the hip with strategies analogous to pre-game football huddles. For them, the market is a casino, a place where traditional financial analysis is shunned.

gamestop shares shortselling

Instead, phrases such as "I like the stock" satisfy the burden of proof for a company's upside potential. The riskier the trade, the greater the kudos.

Short sellers, on the other hand, borrow stock from brokers with a contractual obligation to return it at a future date. They then sell the borrowed stock on the market. If the stock falls in price, the short seller buys the stock back from the market, returns it to the broker and pockets the difference.

However, if the stock goes up in price, the short seller has to buy it back from the market at a higher price and return it at a loss.

But short sellers don't just wait and hope for their shorted stock to fall. They typically release research papers that claim the stock is doomed to encourage other investors to sell it and thereby precipitate a fall in price.

Earlier this week, WallStreetBets turned its attention to terminally-ill company GameStop, in part because it was the underdog of all underdogs and also because they got wind it was shorted by Melvin Capital.

But they were also getting behind forum member DeepF***ingValue (DFV), who had made an initial US$50,000 investment in GameStop which they posted this week had risen in value to $US47 million.

The play quickly gained traction, elevating the stock price more than 3600% from where it was six months ago. Forum members were all in, with one even claiming they'd remortgaged their house to buy GameStop shares.

To a lesser extent, WallStreetBets did the same thing with AMC Entertainment Holdings Inc. and BlackBerry. The frenzy even reached our shores. Shares in the ASX-listed mining company GME Resources soared, likely because investors confused its ticker code with GameStop.

GameStop's moonward trajectory put Melvin in a short squeeze, forcing them to cover their position by purchasing more of the stock to minimize their losses, given they're obligated to return the full position at a future date. Ironically, this move to cover the position adds fuel to the fire because it pushes the stock price higher.

This put Melvin Capital in dire straits, forcing the hedge fund's backers Citadel and Point72 to inject about US$3 billion into the fund to keep it afloat.

It didn't work. Melvin Capital exited their short position, with data firm S3 Partners claiming hedge funds have lost in the order of US$5 billion year to date.

Beyond the entertainment of it all, the GameStop action has fueled debate about the advantage Wall Street investors have over retail investors through, for instance, the ability to front-run the market through high-speed and after-hours trading.

"What you're seeing is a push-back against the establishment," says Social Capital CEO Chamath Palihapitiya.

"In 2008, Wall Street took an enormous amount of risk and left retail investors holding the bag... a lot of [WallStreetBets] kids were in high school, they lost their jobs, their parents lost their jobs, and they've always wondered why [Wall Street] got bailed out after taking enormous amounts of risk while no one showed up to help their parents."

Palihapitiya seems to have read the room well.

An open letter posted on the forum reads: "To Melvin Capital: you stand for everything that I hated during that time. You're a firm who makes money off of exploiting a company and manipulating markets and media to your advantage. Your continued existence is a sharp reminder that the ones in charge of so much hardship during the '08 crisis were not punished."

Nor has Wall Street found a shoulder to cry on among liberal politicians.

"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," tweeted Alexandria Ocasio-Cortez (D-NY).

Even Elon Musk, whose company Tesla has its own checkered history with short sellers, tweeted "Gamestonk!!" with a link to WallStreetBets.

The class war then levelled up when the share trading app Robinhood added a good dose of irony to its name when it blocked its users from trading GameStop.

Of course, there are two sides to every fight, a fight which may extend to Australia.

"In Australia, ASIC is concerned about social trading and has warned retail investors to be cautious about copy trading offered by low-cost trading platforms such as eToro," says Angel Zhong, a senior lecturer in finance in the School of Economics, Finance and Marketing at RMIT University.

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David Thornton is a journalist at Money magazine. He previously worked at Your Money, covering market news as producer of Trading Day Live. Before that, he covered business and finance news at The Constant Investor. David holds a Masters of International Relations from the University of Melbourne.
Comments
Mike Richards
January 31, 2021 7.08pm

Come on now David, it's SO much more than this.

What about the way that the fund managers have kicked and screamed like a spoiled child to Congress, the SEC, everyone and anyone else who would listen to them for a bailout / market stop / investigation, the way that the MSM has howled about the way Wall Street has just had theirs handed to them as somehow being "illegal" (sorry, but good luck finding a charge to stick - no one ever complains when a stock goes up, do they ?) versus the measured, rational commentary from Saagar Enjeti (which is actually on the money).

Oh, and don't miss the other add-on stories too - that Yellen got paid $810,000 to give speeches to Citadel, that Citadel have an agreement with RobinHood for the latter to give them trading data and that RobinHood have deliberately strangled trade in that (and other) shorted stocks. Add that BigTech went and removed thousands of negative reviews about RobinHood too..."nothing to see here" and any reasonable person should be very angry with Wall Street, yet very happy to see them get something so richly deserved and overdue.

The Wall Street hypocrisy is amazing, but the irony is delicious.

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