Tech

What happens when the internet realizes the stock market is basically a casino? They go shopping at the Mall

Analysis So it seems 2021 is going to be the year that internet culture finally reaches the deepest and most protected pockets of society.

The past day has seen the kind of demented activity on the stock market that normally comes with an era-defining crash: except in this case it was Reddit readers who are, um, having a laugh while trying to make a point at the same time.

What started out as a fun way to stick the middle finger up at the super rich has morphed into something that could wipe out billions of dollars, destroy companies, and has regulators sounding panicked. On Wednesday morning, the White House said it was monitoring the situation.

It can often be hard to explain how financial markets even work given layers upon layers of complexity. But in this case, everyone can point to a simple datapoint: shares in GameStop – you know, the box store that sells computer games. They stood at $70 on Monday but stood at $347 at market close, and oscillating between $250 and $315 in after-hours trading.

That means if, just two days ago, you bought $1,000 worth of stock in a company that everyone agrees is likely headed for the scrapheap because you can simply download or stream games these days, today it would be worth about $5,000. That’s $4,000 profit for doing nothing. More importantly, however, is the fact that the company at the center of it, GameStop, has also done nothing.

It’s worth noting that the $70 Monday price was also an aberration. The real value of the stock is likely just $5, which is where it had hovered, rather uninteresting, for an entire year until the start of September. Just to do the math again, if you bought $1,000 of the company’s stock four months ago, it would currently be worth about $70,000.

What’s going on?

So what is going on and what the hell does this have to do with Reddit? (And how do you get a piece of the action?)

The short answer is that the internet has discovered that the great and fabled stock market is often little more than a casino. The internet not only discovered that fact but realized that thanks to a new generation of apps that allow to make commission-free trades by simply tapping your phone, it could also play at the tables.

All it took then was millions of people stuck at home thanks to a pandemic, a meme, and the cartoonish side of Elon Musk to light a tinderbox. Here’s then is a simplified version of what happened and what is going on, from what we can tell:

  • Amateur investors looking to use their new apps to buy stocks and make fast money grew almost immediately impatient when they realized the dull and time-consuming process of investing wasn’t much fun and didn’t make them much money. So they started watching what the risk-taking pros – hedge funds – do to see if they can emulate them.
  • Hedge funds are basically professional stock market gamblers and they try to get ahead of any movement in share prices. They buy/sell shares to make a profit from the small variations. Those variations aren’t really worth chasing as an individual: the cost of buying and selling a share can often be more than the money you make. But if you buy vast quantities of those shares, even small changes can result in real money: millions of dollars.
  • Hedge funds don’t have the billions of dollars needed to make these kinds of bets, so they strike deals with companies that already hold large numbers of the shares in question. They agree to “borrow” the shares for a fee and return them later. The company that owns the shares likes the extra pocket money and the hedge fund guys get to play multi-billion-dollar roulette.
  • In this case, at least one big hedge fund decided to bet that GameStop’s shares were going to fall and so it “borrowed” a huge number of shares in the company and then sold them. The plan was then to wait until the shares were cheaper, buy them all back at a lower price, and then “return” them to the owner, pocketing the difference.
  • If this sounds risky, it’s because it is. It’s called “shorting” and the hedge fund has to give those shares back so if the price doesn’t fall or, worse, goes up, they have to buy back the shares. The small variations can work both ways: you can suddenly owe the millions of dollars you were hoping to make.

Now, your app-based, Reddit-reading investor is in no position to persuade companies to lend them millions of dollars of shares. So they have been trying to follow in the hedge funds’ wake, watching what they do and jumping in fast in the hope of doing the same.

This almost never works because the moment vast quantities of shares are sold, the stock market starts readjusting itself. Everything works at crazy levels of speed thanks to computers (which make the bulk of the buying/selling decisions by volume). By the time your average netizen has seen the hedge fund trade and tried to get in on the action, the price has already moved. It’s fruitless, pointless, and can prove expensive.

As such, it’s fair to say that the Reddit investors don’t much like hedge funds: they are doing what they want to do and winning. And so, when a group of them saw hedge funds short shares in the company that they know – hey! It’s GameStop – they decide to get their revenge.

If people sell shares, the market sees it as people trying to get rid of them before the price goes down. With enough money behind it, short sellers can manipulate the market to do this for them and then scoop up the cheaper shares. But what if people start buying the shares instead? Then the price goes up. And if you get enough people buying, the share price can go beyond what it was originally – meaning that when the short seller is required to “return” the shares, they make a huge loss.

This was the game plan organized on Reddit, quite openly. But then, amazingly, it actually worked: the share price when up, the hedge funds started panicking – and that’s when things went bat shit crazy.

Welcome to the Thunderdome

All of a sudden, the people who had bought the shares realized that the share price had gone past what they paid for it. They were now making a profit. They could sell, of course, but what if the price went even higher? They’d make even more money.

So the celebrations about screwing over a hedge fund turned into something else – encouraging people to keep buying the stock. Let’s bankrupt the fund! And if at the same time we happen to make a ton of money as well, all the better!

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In fact, the hedge funds started having to borrow billions to cover what they owe, with the expectation than when things get back to normal and the share price goes backs down, those debts will effectively disappear.

But the fact this was happening at all, and that the funds might get away it, pulled in more people. Many of whom figured it was worth a risk, and started spending small sums to buy more GameStop shares in the hope it would keep rising. Which of course it did because more people were buying shares hoping the price would go up. Which of course it did because more people were buying shares hoping the price would go up. Which of course it did because more people were buying shares hoping the price would go up. Repeat ad nauseam.

Somewhere in the middle of all this, celebrity entrepreneur Elon Musk noticed what was happening and tweeted a single word “Gamestonk!” with a link to the Reddit board where much of the activity had been planned: r/wallstreetbets.

Musk tweeted just as momentum was building. At 12pm on Tuesday, GameStop’s share price was at $87. At 1pm, when he tweeted, it had jumped to $105. At 2pm it was $115; 3pm, $132; 4pm, $146.

But the bigger impact was that it enabled people to put a famous name and face on the story. As everyone finished their workday and checked out the news, the story of the crazy GameStop share price jump had exploded far beyond the financial media and was all over mainstream news and social media.

The market shut down, as it does every night, giving millions of people time to get think about how they were going to make money the next morning. In less than an hour of opening, the share price had more than doubled.

It’s gone up and down all day with a low of $270 and a high of $373 as the market has played chicken with itself. And that’s how GameStop’s share price was, at time of writing, at the insanely high price of about $350 when it’s probably only worth $5.

A lot of bad options

There is however a very big problem. And that is that a lot of the people piling in to buy the stocks haven’t actually bought them. Just like the hedge fund managers “borrow” shares, many of the app and Reddit investors, dubbed the retail investors, have “bought” the shares through “options.”

Apps like Robinhood let you buy stocks through a call option, where you say you’ll buy a stock at a specific price on a specific date. You don’t have to pay anything upfront: which is amazing if you offer to buy the stock at a higher price than it is currently worth. In fact, because you promise to pay that larger amount, you can buy a contract that will give you those shares right now for less than the actual share price.

If that sounds too good to be true, it’s because it is: you still have to buy those shares on that date at the higher price. Except of course, if the share price goes past what you promise to pay then you can easily sell that contract to someone else and cash in. Or you can keep your contract, buy them at the price you agreed and immediately sell them to make a profit.

It’s not at all clear that people using their apps understand what is going on behind the scenes: many of them see the ability to buy shares at one price and then see what the value of their shares currently are and, so long as the share price keeps going up, they get richer and richer.

And that’s where the memes and screengrabs kick in. Reddit posters have been taking grabs of their phone screens showing massive profits, millions and tens of millions of dollars; causing more people to jump in and buy the same shares, causing the share price to go up, making them more money, causing more people to join in, causing the share price to go up.

This morning, this frenzy of activity grew so intense that several trading platforms fell over under the weight. But all everyone sees is the exponential share price curve pointing upwards.

What happens next?

What actually will happen at some point very soon is that the share price will implode. The moment people suspect that the peak has been reached and they start selling, it will cause a collapse in the price.

This is really bad news for the amateur investors for two reasons. For one, literally no one will buy their call options. The moment it tips, and that tip could easily be the SEC deciding to shut the whole thing down, those options will be effectively worthless because no one is going to buy anything they think will lose them money seconds later. But the contract will still be there.

You can only hope that people have not risked more money than they can easily lose but when the promise of free money is one tap away, you know that lots have.

The other bad news for amateur investors is that the big boys will always, always get there before you. They have teams of people who do nothing all day but watch the markets and are plugged into the system. And they have access to funds.

Even if, somehow, the last few days of crazy speculation end up with some Reddit investors winning out, perhaps even bankrupting a hedge fund, it will be a one-off. Because next time, the people who do this for a living will already be up to speed. In the time it takes to type in a few numbers and hit a button on your smartphone, the entire market will have sold out from under you by someone sat at a terminal wired into the system.

All of which is to say: that has been a wild ride. There will likely be repercussions, controls put on apps and so on and Reddit, for a few weeks, will be another piece of input for traders.

The board where it all started, Wall Street Bets – its description is “Like 4chan found a Bloomberg Terminal” – made itself private for about an hour tonight, but is visible again for all to see. Discord, meanwhile, shut down the chat server used by the sub-reddit’s denizens.

If you are currently holding any GameStop stock, get out, like right now. Take your profit, buy something nice, and be happy. Because it won’t happen again. ®

PS: None of this is financial advice. Investments may increase or decrease. You will not sue. You will not sue.




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