Impact of retail investors and social media on stock markets

From: allin

The role of retail investors, amplified by social media platforms, has dramatically impacted stock markets, most notably seen in the GameStop saga [00:01:47]. This phenomenon highlights a shift in market dynamics, where collective action by individual investors can challenge traditional institutional power [00:09:17].

The GameStop Saga

The GameStop event originated from a Reddit subreddit called Wall Street Bets [00:01:47]. Users on this forum identify potential investment opportunities, share theses, and collectively bet on stocks [00:01:53].

Timeline of Events

• June 2019: A Wall Street Bets user, “DeepF***ingValue,” began buying long-dated GameStop (GME) call options, investing $50,000,whichlatergrewtoapproximately$25 million [00:03:59]. This user consistently posted screenshots of their position, titling them “GME Yolo Update” [00:05:03].
• August 22, 2019: Michael Burry, known from “The Big Short,” disclosed a three percent position in GameStop. He noted that 90% of GameStop’s 5,700 stores were free cash flow positive and urged a share buyback, making a “deep value oriented fundamental thesis” [00:05:08].
• August 31, 2020: Ryan Cohen, founder of Chewy, acquired an almost 10% stake in GameStop [00:06:31].
• September 19, 2020: A Wall Street Bets member highlighted GameStop’s 120% short interest. This user argued that GameStop had several positive factors: a new console cycle, consoles not going immediately digital, 55 million loyalty program users, a strong balance sheet, Ryan Cohen’s stake, and potential for a “big squeeze” due to shorts being underwater [00:06:44].
• November 16, 2020: Ryan Cohen wrote a letter to the GameStop board, urging a strategic review and a plan to evolve the company into a technology company focused on digital experiences, rather than remaining a brick-and-mortar video game retailer [00:07:26].
• November 2020: It was noted on Wall Street Bets that Melvin Capital, a hedge fund, had been synthetically shorting GameStop for over four years by going long on puts [00:07:56].
• January 2021: GameStop struck an agreement with Ryan Cohen, adding him and two Chewy affiliates to its board, bringing e-commerce and strategic planning experience [00:08:24]. The stock rose 13% that day to about $20 a share [00:08:45].
• January 12-13, 2021: Intense activity around GameStop occurred on Wall Street Bets, Discord, and StockTwits, fueled by the belief in Ryan Cohen as a “savior” [00:08:51].
• January 14, 2021: The stock closed at $40, up 125% [00:09:10].
• January 12 - Present: A battle ensued between institutional investors shorting GameStop and retail investors buying the stock and call options, leading to a “crazy nonsense” [00:09:17]. Institutions became “massively short,” even exceeding the actual number of shares, reaching 140% short interest [00:10:04]. Retail investors “aggressively purchase[d] all these cobble options” [00:10:15]. Quant funds and momentum hedge funds also joined the long side [00:10:29]. Over seven trading days, more than $100 billion of GameStop stock was traded, exceeding retail capacity [00:10:35].
• January 19, 2021: Citron Research, a firm known for finding shorts, announced they were short GameStop, predicting it would fall to $20whenthestockwasat$35-$50 [00:11:06].
• Following Days: GameStop calls hit an all-time high, leading to a two-day rally of almost 70%, initiating a “gamma squeeze” [00:11:24].
• January 25, 2021: Ken Griffin (Citadel) and Stevie Cohen injected almost $3 billion into Melvin Capital, the short firm [00:11:37]. The squeeze continued, forcing hedge funds to post more collateral, leading them to cover other shorts and sell long positions, causing wider market impacts on stocks like Facebook, Netflix, and Alibaba [00:11:52].
• January 28, 2021: Brokerage firms, including Robinhood and Interactive Brokers, prevented users from buying GameStop and other selected stocks, allowing only selling [00:12:34]. This caused a 44% sell-off initially, though it later reversed [00:12:44].

Short Interest and Leverage

The short interest in GameStop reportedly reached 120% or even 140% of existing shares, indicating that more shares were shorted than actually existed in the market [00:06:50]. This highlights a fundamental flaw in the financial system’s ability to track beneficial ownership and manage leverage [00:36:08].

Robinhood’s Role and Business Model

Robinhood, a platform praised for democratizing stock trading and enabling millions of millennials to embrace it through free and friction-free services, found itself at the center of the controversy [00:16:29].

Payment for Order Flow

Robinhood’s business model relies on “payment for order flow” [00:13:54]. They don’t charge consumers directly but monetize by monitoring and selling order data to prime brokerage institutions like Citadel milliseconds before trades execute [0:14:00]. Citadel, responsible for 47% of all payment for order flow volume, paid Robinhood almost $100millioninonequarter(a$400 million annual run rate) [00:14:26]. This allows firms like Citadel to front-run trades [00:14:20].

Liquidity Crisis and Trading Restrictions

The decision by Robinhood and other platforms to restrict buying was likely due to a liquidity crisis, where they lacked sufficient capital to post the margin required by their partners [00:03:34] [00:13:23]. When a user buys a call option, Robinhood becomes “synthetically short,” meaning they have to post margin [00:29:11]. This issue had occurred before in March 2020 [00:23:47].

Impact of Restrictions

The decision to halt buying but not selling created immense “one-way pressure” on the stock [00:12:44]. This cost individual investors “hundreds of millions, probably billions, maybe even tens of billions” in economic loss by preventing them from participating in trades [00:03:48]. Critics argued this was a platform-level decision, not universally mandated by regulators, and potentially allowed hedge funds time to regroup and unspool their trades [00:13:08] [00:26:31].

Critiques of the Financial System

The GameStop event exposed perceived flaws and inequities in the financial system.

”Synthetic Casino” and Lack of Capitalization

Stock trading has largely become a “synthetic casino” or “gambling model” rather than a mechanism for capitalizing businesses [00:33:10]. In 2020, $121 trillion of notional equity volume was traded in the US across 2.7 trillion trades, with only a tiny fraction contributing to business capitalization [00:34:05]. This system allows trading firms and hedge funds to profit immensely, diverting capital from job growth, innovation, and economic prosperity [00:33:21].

Precedent: Long-Term Capital Management (LTCM)

A historical parallel is the Long-Term Capital Management (LTCM) crisis in 1998 [00:37:39]. LTCM, with $4.8billionincapital,borrowed$125 billion, leveraging themselves 26 times [00:38:14]. This created 60,000 trading positions worth $1.4 trillion, all synthetic with no actual capital movement [00:38:20]. US regulators had to orchestrate a bailout from banks to prevent systemic collapse [00:39:03].

Proposed Solutions

Several solutions were proposed to address systemic issues:

1. Modern Technology for Ownership Tracking: Use technology (e.g., blockchain) to ensure a single share of stock is not loaned out multiple times, preventing scenarios of over 100% short interest [00:36:04].
2. Leverage Limits for Hedge Funds: Implement strict leverage limits for hedge funds, similar to those for systematically important banks, to prevent them from causing systemic risk [00:37:00].
3. Improved Disclosure: Mandate weekly or monthly public disclosure of all holdings by trading entities, allowing watchdogs to identify risks faster [00:39:26].
4. Open Trading: Ensure platforms cannot arbitrarily decide what can be bought or sold [00:39:53].
5. Short-Term Trading Tax: Implement a 0.1% tax on every share sold, reducing high-frequency trading and encouraging long-term investing [00:41:02]. This could generate hundreds of billions in revenue, potentially replacing capital gains tax [00:40:45].

Social Media’s Influence and Decentralization

The GameStop event highlighted how social media platforms enable collective action, mirroring trends seen in politics and other societal areas.

From Mobs to Movements

Social media platforms facilitate both “mobs” and “movements” [01:07:27]. While mob behavior can lead to negative outcomes like cancel culture or real-world violence (e.g., Capitol riots), movements, like Wall Street Bets, can empower individuals to challenge established powers [01:05:30].

Collective Belief and Market Outcomes

The phenomenon shows that “people can dream a stock to be anything and make it true” [00:54:48]. The value of a stock can be driven by a collective belief in what it could be, rather than just fundamental performance [00:55:04]. This was observed with Tesla, where belief in Elon Musk’s vision drove the stock price, enabling the company to raise capital and build the business [00:53:48]. Similar dynamics are seen with Bitcoin and political figures like Trump [00:54:03].

Censorship Concerns

The decision by Discord to ban the Wall Street Bets server and Robinhood to restrict trading were seen as acts of censorship by powerful institutions against grassroots movements [00:56:17]. This drew parallels to the de-platforming of Trump and Parler, raising concerns about a “slippery slope” where censorship, once accepted for one group, can be weaponized against others when those in power feel threatened [00:57:12] [00:57:33].

Decentralization as a Response

This perceived institutional censorship is expected to drive people towards decentralized systems for trading, communication, and other services [00:55:46]. The belief is that people do not want to trade or communicate on systems that dictate their actions [00:58:15].

Future Outlook

The short positions in GameStop have not been fully covered, with 55 billion shares reportedly still shorted out of 70 million total shares and 47 million in the float [01:09:33]. This indicates that “something very bad could still happen here” [01:09:40].

The future of GameStop and other meme stocks remains uncertain. While the “house always wins” in the long run [00:44:03], the “wisdom of the crowds” or “mob behavior” means that the collective actions of millions of individual investors can shape the market in unpredictable ways [01:13:55]. The core question becomes “who gets to decide” the value and rules of the game [01:14:28].