Wall Street vs. Meme Street: Reddit Retail Traders Flex Newfound Financial Muscle -

By Brendan Eagen

The meteoric rise of GameStop’s stock price has caught the eye of Capitol Hill, with some legislators asking for regulators to take a bigger role in overseeing markets, and others calling for investigations into the popular trading platform Robinhood after they temporarily suspended users’ abilities to purchase select stocks.

GameStop, a brick-and-mortar video game retailer that has struggled in recent years amid the continuous rise of e-commerce and online video game downloads, saw the price for shares of its stock rise over 400% from Monday, January 25, to Friday, January 29. The stock’s rapid ascent, driven largely by the collective purchasing power of small retail investors on the social media site Reddit, appears to have caught Wall Street insiders by surprise, and has already cost hedge funds that had shorted the stock billions of dollars.

Robinhood, the commission-free trading app popular among retail traders, is under fire after it temporarily halted its users’ abilities to buy shares of Gamestop, AMC, and other stocks that had gone viral during the week. Displeased users have begun filing a class action lawsuit against Robinhood, accusing the brokerage firm of “purposefully, willfully, and knowingly removing the stock ‘GME’ from its trading platform in the midst of an unprecedented stock rise thereby depriv[ing] retail investors of the ability to invest in the open-market and manipulating the open-market.”

The restrictions put in place by Robinhood prior to the start of trading on Thursday, January 28 found rare common ground between lawmakers on the left and right. Rep. Alexandria Ocasio Cortez (D-NY), Sen. Ted Cruz (R-TX), and Donald Trump Jr. bashed Robinhood’s decision, agreeing that the firm should be investigated for handicapping retail traders while hedge funds were still able to buy and sell the stocks freely.

Other legislators see the highly volatile situation of viral stocks as evidence that regulators should step in to curb speculation. In a letter to the acting SEC chairwoman Allison Lee, Sen. Elizabeth Warren (D-Mass) described the frenzy as “another example of gamesmanship” interfering with the “‘fair, orderly, and efficient’ function of the market.” Additionally, incoming Senate Banking Committee chair Sen. Sherrod Brown (D-Ohio) has promised a hearing on stock market activities. The SEC released a statement on Friday confirming that it is “closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices.” The statement also addressed Robinhood’s suspicious activity and promised to protect retail investors where “abusive or manipulative trading activity” is found.

The chaos and confusion of the week have left many wondering how a group of small individual amateur investors were able to beat some of the most powerful hedge fund managers at their own game. The answer lies within a common practice at hedge funds called short selling. Hedge funds short sell by borrowing shares of a stock from a broker and selling them with the promise to buy them back and return them by a specified expiration date. When a large portion of a stock has been shorted, and many of the short positions expire soon, the result can be a short squeeze. In a short squeeze, a large number of short sellers trying to “cover” their short positions by trying to purchase the stock at the same time skyrocket the price beyond what a normal evaluation would be.

Reddit users from the site’s forum wallstreetbets, where amateur daytraders discuss their speculative activities, are largely credited with catalyzing the short squeeze. The potential for a short squeeze of GameStop was recognized on r/wallstreetbets all the way back in April 2020. In a post titled GameStop (GME) – THE BIGGEST SHORT SQUEEZE OF YOUR ENTIRE LIFE, one user points out how heavily shorted the stock was—around 80% at the time. Shares of GameStop steadily rose from a low of $2.80 in April and climbed as high as $20 by the end of 2020. The upward trend accelerated in 2021, as investors gained more confidence in the stock after strong 2020 holiday sales and news of Chewy.com founder Ryan Cohen’s appointment to the company’s board. GameStop was also the most shorted stock in U.S. markets by this point. From there, the combination of retail traders buying and holding GameStop shares along with hedge funds attempting to close short positions amid rising GameStop prices led to the jaw-dropping 1000% gains for the previously damned stock.

The success of these small retail traders has not come without risk, especially for those buying GameStop at the current prices. As the short sellers look to exit their positions, the squeeze could end at any moment, leaving those who have not cashed in out of luck. This risk is not lost on r/wallstreetbets users, many of whom, in the execution of this “beautiful” short squeeze as CNBC host Jim Cramer put it, have demonstrated a deep understanding of financial markets. For many average people, the squeeze has become a tool of revenge against large hedge funds, for whom 2020 was the best fiscal year since 2009 as the rest of the economy experienced the negative effects of the pandemic.

The short squeeze has led at least one hedge fund, Citron capital—a large short seller of GameStop—to stop advising investors on shorting stocks.