Last week, a Reddit group by the name of “Wall Street Bets” made history when users pushed stocks to extreme highs in a fight against big trading firms.
It isn’t hyperbole to say this frenzy may have permanently altered the way markets work.
Over the years, hedge funds had been increasing their shorts on the GameStop (ticker: GME) stock. Shorting is a type of trade that results in profit if the price of the stock goes down. If the price of the stock goes up, the shorter can lose excessive amounts of money. When normally investing, the lowest a stock price can go is zero. However, with a short trade, the stock’s price can rise infinitely — this can cause an unlimited loss if the order doesn’t have safety precautions in place.
In the case of GameStop, hedge funds such as Melvin Capital shorted 130% of the available GameStop shares. These hedge funds borrowed shares in order to sell them under the assumption that they could be bought back at a lower price. They made a bet that the company would go bankrupt.
But then came a day trading group on Reddit, known as r/wallstreetbets. Users within this group realized they could band together and pump a lot of money into GME. As a result of sufficient bullish pressure, they drove up the price of the stock and caused what is known as a short squeeze. The hedge funds who shorted the stock were forced to buy it back at a higher price, which caused an even greater upward surge in the stock.
By Thursday morning, the stock gained lots of momentum, caught the public’s attention and began skyrocketing. By this time, GME had risen over 1,900% from Jan. 4 - Jan. 27. This abruptly came to a halt when Robinhood, the company that many were using to trade the stock, stopped their users from buying GME. Oddly enough however, users were still allowed to sell their stocks.
Many speculated that Robinhood may have been trying to force the stock’s price downward by restricting access to it. The next morning Robinhood restricted its users to only buying 1-2 shares of GME. Vladimir Tenev, CEO of Robinhood, cited financial regulations as the reason behind restricting trades for GME in an interview with CNN.
During a livestream on the Clubhouse app, Elon Musk had the opportunity to question Tenev directly.
“Spill the beans man, what happened last week? Why couldn’t people buy GameStop shares? The people demand an answer!” Musk said to Tenev.
Tenev responded that the National Securities Clearing Corporation (NSCC) requested $3 billion as collateral due to the volatile trading, “an order of magnitude greater than what it typically is.” Tenev said Robinhood simply didn’t have enough capital to make this payment, and were required to halt trading of certain stocks as a result.
But Robinhood has still come under scrutiny for a potential conflict of interest.
The platform receives revenue from a market maker called Citadel Securities. Market makers are responsible for placing the actual buy/sell orders from investors. According to a report in the Wall Street Journal, “about 41% of U.S. retail stock-trading volume goes through Citadel Securities.”
Then there’s the Citadel hedge fund, which was founded by Ken Griffin, the same individual who founded Citadel Securities. Citadel is one of the largest hedge funds and market makers in the U.S. Robinhood sells information regarding what stocks users are buying and selling to Citadel. This alone muddies the waters. The Citadel hedge fund bailed out Melvin Capital last week with a $2.75 billion dollar investment. Melvin had an aggressive short position on GameStop.
It’s not entirely clear yet if Robinhood was just following financial rules or engaging in deceptive practices. Some have labelled this market manipulation by big hedge funds, and there is a degree of evidence to make this claim plausible. It is also not clear what will happen to GME or the retail investors who own the stock.
What this has shown, however, is that retail investors can wield enormous power in the market. Perhaps this may be a force for good, a tool to boycott business malpractice and support ethical companies.
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