GameStop fever, r / WallStreetBets and the stock market frenzy, explained

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• GameStop fever, r / WallStreetBets and the stock market frenzy, explained

American video game retailer GameStop found itself at the center of a trading frenzy this week that saw its price jump from €18 earlier this month to over €450. The market mania was fueled by a community of hobbyist traders on Reddit , whose goal is to increase the share price and put pressure on short sellers, who had bet against the company. Redditors have also looked at other stocks that institutional investors believe will perform poorly this year, such as BlackBerry, Nokia and AMC. As a result of the pressure on short sellers, some hedge funds suffered massive losses, in the order of several billion dollars. However, day traders themselves are also at risk, and the inevitable market correction is expected to leave many out of pocket. If you're not a stock market enthusiast, some of the jargon going around will be hard to follow. So we are here to explain what happened, how and why.

What is r/WallStreetBets?

Anyone familiar with the Reddit social content platform will know that the website is divided into many different communities, known as a subreddit. Each subroutine caters to a different hobby or interest. r/WallStreetBets is a sub that describes itself as "a community for making money and having fun doing it." Or, realistically, a place to come and vote for memes when your wallet is depleted. The content feed is a unique cocktail of serious investment theses, brokerage recommendations, memes, and rocket emojis. The community even has its own language to describe different types of investors or stock market events. For example, an investor at r/WallStreetBets is described as "diamond hands" if he is known to never sell, and "toilet paper hands" if he is willing to close his investment position at the slightest sign of a slowdown. The push to increase GameStop's stock price came from this community, but has since captured the imagination of a much larger group of hobbyist investors (also known as retail investors).

What is short sale?

Short selling is a practice that allows an investor to profit from the falling price of a specific stock. Traditionally, these types of games are played only by institutional investors, although there are ways in which an individual investor can also sell a stock. More famously, hedge fund manager Michael Burry (played by Christian Bale in The Big Short) killed the real estate market before the 2007 financial crisis. By predicting that a business or market will fail or fail altogether, a seller in short borrows a specified number of shares from an existing holder, which he promises to repay by a specified date. After borrowing the shares, the short seller immediately sells them at the current market rate. If the price of a share that was worth €10 per share fell to a value of €3 per share, the short seller would pocket €7 per share on redemption from him to return to the original owner. If the company went bankrupt, the short seller would pocket the $10 per share. However, if the stock price were to rise, the risk to the short seller is theoretically unlimited. And that's the dilemma facing a number of hedge funds today, which have shorted GameStop, BlackBerry, AMC and others. One such hedge fund, Melvin Capital, closed out its position on GameStop earlier this week, crystallizing billions of dollars in losses. The hedge fund had to seek an emergency cash injection of €2.75 billion to make up for it, which will be seen as a huge win by the r/WallStreetBets community.

(Image credit: Robinhood)

What is it all about with Robinhood?

With the sudden surge in interest, stock trading services for retail investors have been subjected to a tsunami of traffic. As the most accessible means by which hobbyists can invest in stocks, many investors rely entirely on these services to participate in the short squeeze, but some platforms have collapsed under the pressure. Popular trading platform Robinhood, which had previously been criticized for irresponsibly gamifying investment, suffered a service outage earlier this week, while Trading 212 was forced to postpone client onboarding midway through the outbreak. Robinhood then made the decision to stop trading the r/WallStreetBets target stock, citing market volatility. Users were able to sell existing shares, but were unable to purchase additional shares. The decision to stop trading deprived the short-seller attack of its momentum, sending GameStop shares tumbling more than 40%. The move sparked outrage from merchants and politicians, who flocked to social media to air their grievances and share theories about the involvement of institutional finance in the move. Alternative platforms like Interactive Brokers, Webull, and TD Ameritrade have taken similar steps, but have so far avoided the level of anger against Robinhood, which is now also the subject of a class action lawsuit. The company is accused of trying to "manipulate the market for the benefit of individuals and financial institutions that were not Robinhood customers." Robinhood was forced to raise a multi-billion dollar emergency funding round from existing investors to stabilize its operations and has since vowed to restore the adjusted shares, though there are limitations.

What happens next?

Whether the war between individual and institutional investors will break out in the coming weeks remains to be seen. However, what is almost guaranteed is that the absence of underlying fundamentals (for example, strong performance metrics) will mean that stocks like GameStop will return to more reasonable levels. When this happens, a large number of retail investors who have piled into the stock are likely to experience significant losses. For this reason, anyone wanting to enter the stock market for the first time should be careful. It is also important that people never invest more than they can afford to lose. The incident is likely to have long-term effects as well, as it has raised a number of important questions that will be hard to put back in your box. The ease with which social networks have been used to manipulate markets and the power of financial platforms over their users will require further investigation. TechRadar Pro will update this article with any additional developments.