Rage of Retail Investors Hurt the Wall Street Giants Big: The Actual Face of the GameStop Battle

Fri, Feb 5, 2021 5:20 AM on Stock Market, Exclusive, Recommended,

Sriyans Rauniyar

The author originally titled this article "The Internet vs the Wall Street: An Interesting Battle of David and Goliath".

Everybody loves money, that’s a well-known fact. This is especially true for those who have made billions and billions of dollars trading stocks all around the world. For all intents and purposes, they are the Goliaths of the industry. What’s even interesting is that these Goliaths amalgamate to earn big while hurting millions of retail investors, firms, and traders in the process.

Tired of seeing the same again and again, a Reddit community decided to take on these Goliath in an interesting battle where they, so far, have succeeded in bullying the big bullies and hurting them in their own game. Yes, I am talking about the Internet vs Wall Street saga, an exciting battle of millions of small Davids versus a few amalgamated Goliaths in a way that the world has never witnessed before.

Fuelled by years of rage at market manipulation, millions of retail investors, driven by a Reddit community, decided to go on a stock war with the giants beating them in their own game. The situation is so interesting that from students studying in high school to workers working in daily wages and from jobless desperately looking for a source of income to people unaware about the market itself, everyone is jumping in to play this game just to witness and become a part of history that will definitely be discussed in years to come. But, what is this all about? What’s actually going on?

Before moving onto the main story, here’s what you need to know about short selling

Certain traders in the stock market earn big by betting against a stock. This process is known as shorting. Consider that you borrow an apple betting that the apple’s value will decrease by the end of the day. You go to an apple vendor, promise him interest, and borrow 10 apples from him at the beginning of your day. You immediately sell them to someone else at the current market price of Rs. 10 each and earn a total of Rs. 100. Yes, it is really that strange. You can sell those apples without actually buying them first. You have only borrowed those apples.

At the end of the day, say the value of an apple drops down to Rs. 5 each. You then purchase 10 apples at the current value of Rs. 5 and pay Rs. 50. You then go on to return those apples to the vendor. How much money do you have left? Rs. 50, right?

The vendor got his 10 apples back. And you made money by selling them at a higher price and returning the apples to the vendor by buying at a cheaper price. Are you with me? This process of betting against a stock is known as shorting.

While this is a game with utmost risk, big hedge funds short stocks on massive scales pocketing millions and billions in the process. However, things can take a wild turn if the value increases instead of going down. Consider this situation now. After you sell the 10 apples for a total of Rs. 100 and wait for the value to go down, the value actually goes up and an apple now costs Rs. 20 at the end of the day. Since you had borrowed the apple, you have to buy 10 apples for a total of Rs. 200 and lose Rs. 100 in the process. While the example shows that the price hiked by only Rs. 10, the loss can turn out to be massive if the price surges exponentially. Whenever price surges and you desperately purchase apples at high prices to return them back to the vendor, the process is called a short squeeze; a situation so unforgiving that many have committed suicides.

So what’s the game all about?

The game began way back in 2020 when GameStop, a brick-and-mortar company, reported continuous losses quarter after quarter causing its stock prices to decline. With the pandemic adding another big nail to the already semi-closed coffin, the company was already struggling to avoid bankruptcy. The bad position of the company caught the attention of big hedge-fund firms - namely Melvin Capital, Citron Research, and others - who started betting against the stocks of GameStop and started shorting them.

On the other hand, Ryan Cohen, co-founder of an online pet supply company Chewy, disclosed in August of 2020 that he had acquired a major stake in the company. Along with Cohen, two other former Chewy executives joined GameStop in January 2021 with an aim to transform GameStop into a digital success story. Following this announcement, the shares of GameStop nearly doubled and caught the attention of certain Reddit users of the subreddit r/WallStreetBets.

With the company showing promises under the new management, many retail investors rushed to buy the shares of GameStop causing its price to rise but at a very gradual rate. The game finally started taking shape when one of the Reddit users, DeepFuckingValue, leaked the position of certain companies, especially hedge-funds, that were showing very deep interest in the GameStop stocks. Beginning from the September of 2019, the subreddit saw continuous updates to the position of the stocks, the volumes traded, and the price with which it was being traded. Following analysis, the users got to know that the stocks of GameStop were being massively shorted by big hedge funds who were raking in big money, especially Melvin Capital.

Retail investors did not do this for money, they did this because they were angry

When Redditors detected that hedge funds were shorting stocks and raking in the money, they decided to strike with a counter-campaign, buying up stocks in thousands and causing its price to skyrocket in no time. This move from the online community was fuelled not only by the rage they had against market manipulation but also by the suicide of Alex Kearns who blamed Robinhood for losing thousands of dollars.

Talking about shorting, the stocks of GameStop was shorted so much that, at a point, the shorted stock volume was about 138% meaning that for every single share of GameStop, 1.38 people were betting against it. For many, this game of shorting is an unethical move of market manipulation. This is exactly why certain Reddit users decided to expose this inefficiency and take on the big Wall Street giants to the battlefield. Following the interest of retail investors from the Reddit community fuelled by social media boosts and memes, the counter-campaign quickly took shape attracting thousands of retail investors from around the country.

At a point, the stocks were surging so high that the company that was once valued at $155 million in the April of 2020 reached a staggering value of about $29 billion dollars in 8 months time, 188 times more than what it was worth before. As the value rose, the retail investors earned big with many even reaching an evaluation of over a million dollars within a month. On the other hand, the desperate hedge-funds, in utmost desperation, fell victim to a massive short-squeeze. In short, they lost in their own game and they lost big.

Doomsday for the Big Guys

Following the scenario in the market, the hedge-funds lost billions of dollars with Melvin Capital losing the most. Melvin Capital hedge fund alone lost 53% in the GameStop frenzy and were bailed out after another hedge fund injected over $2 billion in the company. Not just Melvin Capital, big hedge funds namely Candlestick Capital Management, Citron Capital, D1 Capital Partners, Maplelane Capital, and Point72 reported losses extending into the double digits.

The game again took a turn when big brokerages, especially Robinhood, imposed strict limits in the trading of GameStop stocks. Furious Reddit users and retail investors backlashed these brokerage firms filing multiple lawsuits and raising a massive concern over the free-market trade, something that the US proudly boasts upon.

In fact, Congress hearings seem inevitable after such a move from such brokerages leading to mass speculation that these firms are siding with hedge-fund short-sellers as they are the primary source of income for these brokerage firms.

What are we actually looking at? Where is this headed?

With the retail investors not looking to back out easily, it can only be speculated when this notorious stock war might end. When the retail investors found out other stocks that were also being shorted - namely AMC, Blackberry, Nokia, and so on - they quickly jumped to capitalize and hurt the big players even more. What’s interesting here is that certain big names like Elon Musk are encouraging people not to step down. Let me remind you that Tesla was the most short-selling stock last year and that move cost hedge-funds a collective loss of over $40 billion while Elon clearly made triple that amount.

Currently, many retail investors are sitting on top of a huge pile of money and are not worried about losing big once the market stabilizes back to normalcy. Interesting to know, DeepFuckingValue, the Redditor who helped launch the GameStop trend, posts regular updates on his gains, and has turned an initial $53,000 investment into an astonishing $30 million. Another user who injected nearly $100,000 turned his investment into a whopping $50 million.

It can definitely be said that many retail investors will lose big once the hype dies down and the value of the stock deflates. For hedge funds, they definitely have not got out on top this time. This entire saga can unquestionably be considered a generational clash and a referendum on who controls the markets, pitting an army of retail investors - many of them digital youths - against the big Wall Street players. Though this has wreaked havoc on Wall Street and has turned financial markets upside down, this will definitely be crucial in shaping the future of the stock market and the position of big players in market manipulation and market control.

Sriyans Rauniyar is a second-semester undergraduate student currently studying at Princeton University. With a passion for entrepreneurship and hoping to get into the VC ecosystem in the longer run, he is a keen learner and an occasional writer. Rauniyar serves as an associate at the Princeton Student Ventures, a student-led VC firm. Follow him on Facebook @RauniyarSriyans, on Instagram @sriyans_17, or send him an email at rauniyar@princeton.edu.