If you have internet service and a 20-year-old in your life, then you’ve probably heard about the redditors who took on hedge funds shorting GameStop stock. I first heard about it from one of the streamers I watch on YouTube who knew enough about the stock market to explain exactly what was going on to his audience.
Turns out, most of what happens on Wall Street is meant to go over our heads. As “The Big Short,” a 2015 movie about the Great Recession in 2008, puts it, “Wall Street loves to use confusing terms to make you think only they can do what they do. Or even better, for you to leave them the f**k alone.”
According to the New York Times, by Jan. 28, GameStop shares had risen by over 1,700%. The video game retailer’s market value was about $2 billion in December. By Jan. 27, it had risen to $24 billion (on paper).
According to the Washington Post, it all started when Ryan Cohen, the co-founder of Chewy.com, invested in GameStop. He invested $76 million dollars just last year and began publicly pushing the company to move business online. Hedge fund managers, on the other hand, were publicly claiming that GameStop stock would plummet.
Prompted by Cohen’s investment and in an effort to thwart the hedge funds betting against GameStop by shorting its stocks, the investors who would become responsible for the massive increase in GameStop’s worth banded together on Reddit.
According to its official website, Reddit is “a social news aggregation, web content rating and discussion website.” Users (often called Redditors) can follow themed subreddits to interact with posts about those specific topics. A group of amateur traders found each other under a subreddit called “r/wallstreetbets,” and realized they could do what Wall Street does: make money.
Before breaking it down further, there is some terminology to clear up for anyone who is not normally invested in the stock market. A Ph.D. student in mathematics and computing, posting to Instagram under the name “notvai,” explained it like this:
“First, you need to understand what a ‘short’ is in trading. A ‘short’ is when you borrow a stock from a broker and sell it immediately at its current price. Then you hope the stock’s price falls such that you can buy the stock back at a lower price and return the shares you borrowed to your broker but keeping the difference.”
The New York Times reported that, in this case, the shorts (the investors betting against stock) included at least two big hedge funds. So, what is a hedge fund? According to the Motley Fool, “a hedge fund is nothing more than an investment company that invests its clients’ money in alternative investments to either beat the market or provide a hedge against unforeseen market changes.” It is also worth noting that hedge funds are more expensive and less regulated than conventional investment funds.
Basically, a hedge fund is a brick wall of money.
Now, while avid defenders of Wall Street will tell you that shorting is nothing like gambling, it’s easier to think of it as gambling; the person or, more likely, hedge fund doing the shorting is making an educated guess or a bet on whether a certain stock will go up or down.
And, when this bet goes south, the shorts are forced to buy back the stock they sold for a higher price than they sold it at so that they can return it to the broker they borrowed it from. The shorts can potentially lose massive amounts of money.
In this case, according to SYSCA, a redditor from r/wallstreetbets realized that a hedge fund had taken a large number of short trades against GameStop and convinced everyone on the thread to buy as much GameStop stock as they could. According to the New York Times, these amateurs began driving the price back up by buying stock on platforms such as Robinhood and E-Trade, sites that make trading easier for those outside of Wall Street.
Because so many people were investing in GameStop stock at one time, the price of that stock rose, and the hedge fund’s short position began losing billions. According to SYSCA, their losses surpassed the hedge funds’ original worth of $13.1 billion. The hedge fund eventually had to buy all their stock back at a much higher cost, sending the prices of GameStop stock even higher. What happened with GameStop stocks is called a “short squeeze.”
The New York Times reported that some of the amateur traders said that they invested in GameStop shares because they are a good value.
“Others wanted to squeeze Melvin Capital, a hedge fund that was shorting GameStop. A spokesman for Melvin Capital — which needed a $2.75 billion cash injection on Monday because of the squeeze — said the firm had closed out of its short position. Andrew Left of Citron Research, another short, said he had covered the majority of his position ‘at a loss, 100 percent’,” the New York Times reported.
After this initial spike in GameStop’s worth, enthusiastic amateur investors began focusing on bidding up the prices of struggling stocks such as AMC and BlackBerry.
However, the Washington Post reported on Jan. 29 that Robinhood “shocked investors Thursday morning [Jan. 28] when it abruptly restricted purchases of GameStop, AMC Entertainment, BlackBerry and certain other volatile stocks.”
The big question now is, if we have a free market, then why are the higher-ups regulating stock that the general public has begun to make a profit on?
Both Republican and Democratic politicians have shared their support for investigating Robinhood for freezing GameStop stock. On Jan. 28, Congresswoman Alexandria Ocasio-Cortez tweeted, “We now need to know more about @RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit. As a member of the Financial Services Cmte, I’d support a hearing if necessary.” Texas Senator Ted Cruz retweeted her message, sharing his support.
On Feb. 1, Robinhood user Brendon Nelson told The Verge in an interview that “Robinhood has completely blocked retailer investors from purchasing [GameStop stock] for no legitimate reason.” Investopedia defines a retail investor as “pretty much every person who buys and sells debt, equity or other investments through a broker, bank, real estate agent and so on. These people are not investing on someone else’s behalf, they are managing their own money.” Nelson claimed to The Verge that Robinhood “‘failed to provide adequate explanation for pulling a profitable stock from its platform.”
This freeze on profitable stocks can be seen as an act of class solidarity. According to Coin Telegraph, “The connections between trading app Robinhood, Citadel hedge fund, Melvin Capital and GameStop are becoming clearer.”
Coin Telegraph reported that Citadel and Point72 Asset Management invested $2.75 billion in Melvin to bail out the hedge fund. Robinhood went on restricting trading for GameStop, AMC, BlackBerry and others, preventing retail investors from investing in more shares of the stock and causing the price of GameStop stock to quickly drop by more than half.
Coin Telegraph pointed out that this decrease in GameStop’s stock price seems to benefit Melvin Capital, and that, for a trading app that claims to “democratize finance for all,” Robinhood’s motivations for restricting trades are questionable at best.
“According to the Financial Times, $39 million of Robinhood’s revenues from equities and options order flow came from Citadel Securities, a market maker sister firm of Citadel… In summary, Citadel is one of Robinhood’s biggest customers. Citadel invested in Melvin, which is potentially facing trouble because a bunch of investors from Reddit decided they didn’t like a major hedge telling the market to crush GameStop. Many of the Redditors used Robinhood to buy GameStop shares. Now Robinhood has severely restricted trading for GameStop,” Coin Telegraph reported.
In Robinhood’s defense, the New York Times reported that Robinhood “has grappled with an extraordinarily high volume of trading this week as individual investors have piled into stocks like GameStop. That activity has put a strain on Robinhood, which has to pay customers who are owed money from trades while posting additional cash to its clearing facility to insulate its trading partners from potential losses … To continue operating, it drew on a line of credit from six banks amounting to between $500 million and $600 million to meet higher margin, or lending, requirements from its central clearing facility for stock trades, known as the Depository Trust & Clearing Corporation.”
Business Insider reported that, on Jan. 28, Robinhood raised another $2.4 billion in new funding from shareholders, just days after investors initially put $1 billion into the company in order to meet regulatory requirements on the back of the recent trading mania.
On Feb. 1, Business Insider reported that, “While no legal action has been done, the U.S. Securities and Exchange Commission on Jan. 29 said in a statement it is ‘closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices over the past several days.’
As the connections between these companies are brought to light, many Americans are questioning whether the market is truly free. The Verge reported that Robinhood is facing dozens of lawsuits over their freeze on GameStop stock, and Wall Street better believe that all of America is watching now.