Photo by Breanna Hardy.
Written by Breanna Hardy
GameStop stock has been on a roller coaster ride, sparking outrage from Wall Street after hedge funds lost out on big money. The culprits were amateur traders who banded together via Reddit, an online platform for community discussion.
Local experts say this incident is unique because of the role of social media, and will likely lead to regulatory changes.
Tim Dodd, financial planner and owner of Dodd Wealth Management in Fresno, said that in order to understand what happened with the GameStop frenzy, the public needs to understand short selling.
The Reddit users did.
Where normally a stock’s value would reflect success of the company, Reddit users collectively shifted the market in their favor by buying a large amount of shares of underperforming stock.
“Basically, for every person that wants to buy 100 shares of a stock you must have another person wanting to sell 100 shares of said stock. Some people, in this case Wall Street, were borrowing shares of GameStop from their brokerage firm and selling them with the assumption of the price going down. Once down, they turn around and buy the actual shares for a lower price. Then, like anything else borrowed, one must give it back. The short sellers essentially keep the profit from the price difference,” Dodd said in an email response.
Nick Allen, wealth advisor at Brouwer, DeJong & Associates in Fresno, said, “In concept, the act of shorting a stock primarily focuses on the belief that companies are run poorly or disadvantaged somehow, and could see their share prices fall. As the share prices fall, these hedge funds make money,” Allen said.
The stock grew in demand, and skyrocketed from about $17 a share to a high of $300. As of Feb. 1, the stock was just under $230. On Feb. 2 it dropped to $117 around 9 a.m., and $90 by close of trading. GameStop, along with AMC and BlackBerry, are just some of the stocks that have seen increased volatility. As of Feb. 16, GME is valued at $49.11 a share.
“It’s probably the busiest week of fourth quarter earnings season, which shook companies as a whole in continuing to suppress and surpass all profit expectations,” Allen said.
Though the stock has plummeted, the event sparked a rebellion of sorts, and financial advisors are wondering how history could repeat itself.
“Extreme buying activity across a few of some of the most unloved stocks on Wall Street caused their share prices to soar really high, and this development triggered a number of hedge funds to unwind their short bets this week, which prompted volatility,” Allen said.
Economic data was mixed, but Allen said financial advisors still believe the economy is poised for robust growth this year.
He thinks that the temporary volatility shouldn’t skew investors’ view of the stock market overall.
“Expect volatility to remain elevated for a while, but longer term, investors need to look through this headline noise, which just turns into speculation and therefore leads to the importance of diversification — knowing your risk tolerance and investing accordingly,” Allen said.
Though the stock market might calm down after the GameStop frenzy, social media is here to stay. K.C. Chen, Fresno State department chair of finance and business law and professor of finance, spoke to the role it played in the process.
“We have seen lots of short squeezes in the past, but this time is different because this is initiated by social media,” Chen said. “As you know, the power of social media, they can start up this kind of a short squeeze with so many followers.”
Chen said these retail investors are fighting against the “big boys,” or hedge funds that short stocks. He told his students that these day traders are like an army of ants who moved an elephant.
“If you have so many people working together, they can kill the opposite powers,” Chen said.
It was apparent that these amateur investors did their research, Chen added.
Dodd said that the Reddit users were within the law to trade GameStop stocks. “With any investment comes relative risk. As long as they were not acting on inside information or manipulating the stock price to take advantage, then I don’t believe they broke any rules,” Dodd said.
Chen believes authorities will still look into the matter.
“I think the SEC (Securities and Exchange Commission) has to investigate whether this is some kind of manipulation to begin with,” Chen said.
Robinhood — a popular, commission-free stock trading app — halted GameStop stock trades at the height of the frenzy.
“What if people default on the payments of those shares? Then [Robinhood] will be liable,” Chen said.
“Whoever initiated that thing – those people are very smart, but whether they have a good intention or not, I don’t know,” Chen added.
But he said there’s really no way to prevent this sort of thing from happening with social media now. It’s different than even a decade ago, and he believes that the SEC will have to make more regulations to ensure there’s no manipulation to the market.
Financial advisors continue to speculate whether this will set a pattern for more short squeezes that bet big money against Wall Street.
But before restrictions are set in place — if they can be — brokerage firms are getting a say.
“In the meantime, brokerage firms are widening and/or limiting what they are allowing to put on margin (or borrowed) in order for them to meet their redemptions. Adjustments are already being made to trading platforms. In regards to the extreme volatility in trading a single stock, remember you’ll have two sides — one that wins big and one that loses big,” Dodd said.