The events related to GameStop Corp. shares and Melvin Capital LP which unfolded last week to the astonishment of some and amusement of others have prompted serious questions regarding the proper functioning of financial markets and the legal and moral concerns of this form of modern collective investment. In face of the pace with which these events developed, and the flood of information that followed them, I present a summary on the main ideas to understand one of the most significant challenges the financial system has faced since the Great Financial Crisis.
Firstly, it is important to understand that this was not an isolated episode, but rather one instance of the continued battle between Reddit day traders and Wall Street hedge fund investors, which aims not only at enabling positive returns for the former through collective investment in specific shares (some form of stock bidding up) but also at undermining the latter’s’ financial positions in an anti-establishment spirit. Be their drive a false democratization of financial markets or resentment towards a specific group which represents the historical financial elite, these past events have made one thing clear: Reddit day traders are not here to play.
But what actually happened? Reddit day traders (amateur day traders), who connect through WallStreetBets, have been sharing information on and targeting stocks largely shorted by hedge funds to bid up their prices and undermine the latter’s financial positions. Since Tuesday last week, GameStop shares (GME) have been bid up to unprecedented levels (with a 146.78% price increase), just to plummet subsequently as the short squeeze clarified. This, however, did not lack consequences: it led Melvin Capital (a $13bn hedge fund), among others, to close its short position with considerable losses. Once the commitment and impact of Reddit day traders had been made clear, one of the main trading platforms this group used (Robinhood) suspended trading by disabling users from taking further long positions and causing robust backlash. Other stocks targeted in the same fashion included BlackBerry Limited (BB), AMC Entertainment Holdings Inc. (AMC), Nokia Corporation Sponsored (NOK), and Bed Bath & Beyond Inc. (BBBY), although these did not experience price fluctuations as high as GME.
One of the fascinating aspects of these developments is the successful coordination of numerous individuals throughout the world via an internet forum to decide to invest their personal income and savings, therefore taking a risky position on a stock with un-ideal financial prospects, driven principally not by personal gain, but by alien loss. This phenomenon of collective investment, possible in theory but disregarded in practice (until now), posits several doubts to financial market participants, especially regarding its legality.
In the aftermath of the GameStop bid up, many people, including unsurprisingly those with close ties with hedge funds, have accused the behaviour of Reddit day traders of being a form of (illegal) market manipulation through collusion. Similarly, and to the same level of surprise, those with ties or sympathy towards Reddit day traders have accused the behaviour of Robinhood of being illegal.
It is not clear, however, that either of these is true. In the case of the former, it could be argued, with differing levels of success, that WallStreetBets served as a platform for the sharing of a piece of publicly available information (this being which stocks had been significantly shorted by hedge funds) and based on which each Reddit day trader (without assurance of the actions to be taken by others) acted. On the other hand, the complex functioning of Reddit and its legal obligations (such as possession of a required ratio of the value of transactions in cash) could potentially explain the decision to halt further long positions in the security.
Even though the short squeezes have concluded, the debate on the legality of the actions of both Reddit day traders and the financial trading platforms has not disappeared, nor have the numerous questions which lawmakers and financial regulators will have to answer in the near future, for the battle between Reddit and Wall Street does not seem to have ceased.