Individual Investors Turn Wall Street on Its Head

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The stock market last week took a raucous rollercoaster ride, with prices swinging high and low in the blink of an eye, and volatility soaring. The culprits? Retail investors.

Individual investors, as they are also known, often have less experience and play with smaller amounts of money, generally for themselves. Recent chatter by retail investors in online forums like Reddit's "wallstreetbets" turned to avenging the little guy against big money hedge funds. They urged each other to buy up shares of GameStop, AMC Entertainment, and Bed Bath & Beyond, among others, which some big hedge funds had bet against. The strategy is known as short-selling—investors make money by wagering that stock prices will tumble.

GameStop soared and hedge funds were forced to buy stock and cut their losses, or sell shares in other companies to shore up funding, prompting volatility not seen since before the 2020 election. As of 12 noon Monday, GameStop was down about 24% from Friday’s close, and it seems the story's far from over.

What in the World Happened? 

Individual investors have become more active in the past year, boosted by zero-commission trading from popular trading apps like Robinhood and a pandemic that's kept a lot of people at home and bored. Retail investor trading now accounts for about 20% of stock activity and on peak days as much as 25%, compared to around 10% in 2019, Joseph Mecane, head of execution services at market-making firm Citadel Securities, said in an interview with Bloomberg back in July.

At the same time, game playing has thrived during the pandemic. But with many stores and malls closed, video game retailer GameStop has seen net sales shrivel—they dropped 30% in the third quarter of 2020 from one year earlier. Retail investors took issue when a famous short-seller, Andrew Left, founder of Citron Research, said in an interview with Benzinga on Jan. 21 that GameStop wasn't worth buying and that shares would drop back to $20 from the $40-range.

Retail investors took to forums like Reddit’s wallstreetbets to discuss Left's derision of the stock, urging each other to buy up shares and drive the price higher, resulting in plunging losses for short-sellers. Reddit’s wallstreetbets has more than 6 million members.

On Friday, Jan. 22, TheStreet reported that Citron’s Twitter page had published a letter from Left that said he was abandoning his position in GameStop because of harassment from investors who disagreed with his assessment of the stock. GameStop closed at $65.01 that day, up from $43.03 the day before. The letter reportedly published on Citron’s Twitter page is no longer available.

Seeing Citron’s retreat from GameStop as a victory, retail investors continued to push GameStop’s price higher, hurting other hedge funds like Melvin Capital Management, which had to scramble to buy GameStop shares to close out its short position (the higher the stock went, the more money it would lose, but it had to keep buying to meet margin calls), which pushed the stock even higher in fits and starts.

GameStop more than doubled between close last Tuesday and close on Wednesday, ending the day at $347.51. On Thursday, shares hit an intraday high of $483.00 before plummeting to an intraday low of $112.25, only to jump again and close out the day at $193.60.

Before this year, the stock's previous closing high was $62.88 back in 2007. On Friday, shares closed at $325.

What Happened Next?

Individual investors cheered on forums and hurled insults at Wall Street. Brokerages restricted trading to slow the onslaught. Lawsuits were filed. Regulators and members of Congress began probing.

“Whether you're here for the gains, to stick it to the man as I am, or just to be part of a potentially market changing movement - thank you,” one retail investor wrote on Reddit’s wallstreetbets on Thursday Jan. 28.

Brokerages and trading platforms took swift action to help keep a lid on volatility and mitigate risks, with Charles Schwab, TD Ameritrade, Robinhood, and Interactive Brokers implementing trading restrictions.

Those moves only fanned the flames, and within hours of Robinhood’s announcement, a Robinhood customer filed a class-action lawsuit against the trading platform. The lawsuit claims Robinhood was in cahoots with Wall Street when it decided to restrict trading for its customers, depriving retail investors a chance to participate in the stock surge.

Robinhood defended its action in a statement on its website, saying it had to restrict trade in some stocks because of the sudden surge in the deposit amount its clearinghouses required to cover the settlement period (the time between the trade and when the stock and the funds are transferred.) 

“It was not because we wanted to stop people from buying these stocks,” Robinhood said. “We did this because the required amount we had to deposit with the clearinghouse was so largewith individual volatile securities accounting for hundreds of millions of dollars in deposit requirementsthat we had to take steps to limit buying in those volatile securities to ensure we could comfortably meet our requirements.”

Meanwhile, members of Congress and the Securities and Exchange Commission (SEC) called for investigations into the mayhem. Texas Sen. Ted Cruz and New York Rep. Alexandria Ocasio-Cortez, among others, shared their support for an investigation into Robinhood’s decision on Twitter. California Rep. Ro Khanna even floated the need to consider a financial transaction tax, an idea championed by Massachusetts Sen. Elizabeth Warren.

The SEC said in a statement Friday that, along with its regulator partners, it is monitoring the extreme price volatility and pledging to protect retail investors. They are also reviewing whether regulated entities acted to disadvantage investors.

What Do People Make of This?

“This is the new normal,” Alexis Ohanian, co-founder of Reddit, said in a CNBC interview on Thursday. “We’ve watched the internet now, over the last 10, 15 years thanks to the rise of social media and all this infrastructure, really bring a bottom-up revolution to so many industries. We’ve seen this across the media, we’ve seen this across so many sectors, and now it’s happening to finance.”

Market analysts are also more focused on the idea that these are signs of an irrational market.

“The trading activity is yet another sign of extremely frothy sentiment, which has been building in earnest since last fall," Schwab wrote in a report on Thursday. "Lately, it has entered a unique new phase driven by retail traders.” 

This “irrational exuberance” by retail investors is often seen by analysts as the top of the market. 

“The most impressive features are the intensity and enthusiasm of bulls, the breadth of coverage of stocks and the market, and, above all, the rising hostility toward bears,” Jeremy Grantham, co-founder of investment and asset management firm GMO, wrote in a Jan. 5 letter. "In the last few months the hostile tone has been rapidly ratcheting up."