GameStop And The Revenge Of The Retail Investors

Once upon a week ago or so, evil hedge funds profited from falling stock prices of such companies like GameStop, AMC theaters, and BlackBerry. But a noble band of brave Reddit social network users raised money, invested, and beat back the oppressing forces of Wall Street.

You’ve likely seen the popular stories — GameStop jumped from trading under $20 to reach $483 at one point in January, according to data from S&P CapitalIQ.

“The nice narrative here for a lot of people is the little guy sticking it to the hedge funds,” said Robert Johnson, CEO of Economic Index Associates and professor in the economics and finance department at Creighton University.

The actual dynamics are more complex. Many investor warriors left the field with far less money than they had. Some hedge funds brought in hundreds of millions of dollars.

But a combination of folklore, video gaming ethos, and a script worthy of Hollywood—no matter how distant from reality—may help explain what happens and how, at least a little, Wall Street may have to work in the future.

Old Story Made New

The story started with short selling. Investors—hedge funds, in this case—decide a company’s stock is overvalued, so it borrows stock from a broker or another investor. The shorting investor must eventually return the shares, along with interest.

The investor sells off the borrowed shares. If the stock price drops, the investor buys replacement shares, hands them back along with the interest, and pockets the difference.

But if shares prices rise, the short seller loses money. Since a stock can continue to climb, the short seller can get caught in a short squeeze and ever-increasing losses.

People on the Reddit group WallStreetBets tried to engineer a short squeeze of the hedge funds by collectively buying shares to drive up share prices.

“This is a moralistic bubble,” said David Hirshleifer, a professor of finance at the University of California, Irvine and an expert in investor psychology. “A large part of the reason for buying the stock was to punish hedge funds, which are viewed as bullies or predators who are attacking good firms.”

That’s a sign of growing public skepticism. “Institutional trust in the United States is bouncing around near all-time lows,” said Chris Barnes, managing director of the financial services practice at market research firm Escalent.

Reality Versus Folklore

But for all the talk of David versus Goliath, it was more David and Goliaths versus Goliath, according to Asher Rogovy, chief investment officer for investment management firm Magnifina. “There’s evidence to me that there were institutional traders on the buy-side of this posing as small investors on Internet forums.”

The Reddit crowd set off the price run-up but lacked the resources “to keep up with the frenzy,” said Pamela Sams, a financial advisor at Jackson Sams Wealth Strategies.

That’s where other institutions stepped in, capitalizing on the bubble in a way the individuals couldn’t, even collectively. Still, the “retail investors coordinated quite well in order to gain a great deal of market power,” said Amanda Heitz, assistant professor of Finance at Tulane University's A.B. Freeman School of Business.

There were winners and losers. Some big institutional investors walked away with hundreds of millions in profits. “This is a skill hedge funds have,” Hirshleifer said. “Creating bubbles is not a way to battle against speculative traders.”

However, the short-sellers collectively lost tens of billions. Not all big players were smacked, but some were.

“The large institutions that got hurt on this, honestly, they should [have known] better,” said David Starr, Vice President of quantitative analysis at Simpler Trading, an educational site for traders. “The fact that they didn’t protect themselves is their own problem.”

Similarly, some individuals scored big. On Jan. 27 at 7:04 a.m., Starr bought GameStop shares at $226. By 9:22 a.m., he sold off the last at $379.98—a 68% increase.

On the other side, there was Ryan Zamo, a self-described “proud member” of the WallStreetBets forum. In an email, he said he bought 200 shares of GameStop but ultimately took a “damn beating,” losing $30,000.

But Heitz worried about individuals.

“Everyone is speculating, and a lot of retail investors don’t understand what’s going on in the market,” she said. “I fear that a lot of people came across the Reddit threads, thought they were funny, and don’t understand what can happen to them.”

When The Story Takes Over

Then again, many of them may not have cared. Zamo said he wasn’t worried. This is where computer and video gaming culture meets finance, according to Chris Arnade, author of “Dignity: Seeking Respect in Back Row America” and a former banker and gamer.

“I call it justified cynicism,” Arnade said. “Wall Street likes to take itself very seriously. But it’s really a high stakes game with high barriers to entry. From [the Reddit members’] perspective, the system is rigged. And when you’re playing a rigged game, recklessness is one way to deal with it.”

In gaming, there’s a term called “inting,” which means intentionally letting a character die to undermine the game. Reckless behavior can come when players feel they can’t possibly win.

There was also the moral world, outside of finance, in which the individuals decided to punish big Wall Street players. Within a short time, the storyline became what folklorists call a legend.

“A myth explains how the world came to be,” said Linda Lee, lecturer in folklore in the school of liberal and professional studies at the University of Pennsylvania. “Legends are set in the world we live in” and are portrayed as possible. In this case, Reddit’s merry band—many of whom ironically used the trading app Robinhood to place their orders—dueled with the perceived evils of Wall Street.

The press picked up the David versus Goliath narrative, itself an aspect of religious myth, and added morality play, in which actors embodying virtues and vices.

According to Lee, the reflection of the media back to the WallStreetBets group led to a process called ostension. People look to legends as instructions on how to act. The reinforced narrative drove the individuals to further embrace their image.

The Aftermath

Stories, whether myths, legends, or the simplified so-called hero’s journey that drives so many blockbuster movies, are also more than words. They have power.

Ten years ago, this sort of action wouldn’t have happened. “The very retail investor that’s been so long seen as the potential victim has turned the tables and done so in a way that was likely not anticipated,” said Ken Joseph, head of the regulatory consulting practice for the Americas at Duff & Phelps.

“Typically, we think of communications top-down,” said Chester Spatt, professor of finance at the Tepper School of Business, Carnegie Mellon University. “In this case, they’re bottom-up. I think it’s healthy that we have mechanisms for people to communicate in different ways and it’s not all about who can get airtime on CNBC to hawk their point of view.”

“I think this has accelerated unleashing forces that will try to change things because of lack of trust,” Barnes said. “This won’t be the only time.”

Now the question is, who will be next?