What do the terms “diamond hands,” “stonks,” and “tendies” all have in common? Each is a piece of internet lingo used by members of the Reddit internet community r/WallStreetBets which has found itself at the center of a massively volatile week in the stock market.
Full of internet memes and screenshots of massive wins (and losses), the WallStreetBets forum is a place where users of the popular social media platform Reddit can meet up to chat about gambles they’re making with the stock market. In between jokes and boasts, the pros and cons of different stocks get talked about, as well as certain strategies that can result in big gains if executed with a little bit of luck.
It just so happens that enough Redditors got on board with a strategy called a “short squeeze” in the last week or two to make waves in the stock market—boosting the value of AMC Entertainment and GameStop’s stock, along with other targets like Nokia and BlackBerry.
What’s resulted is a “David and Goliath” situation of sorts, as everyday internet users open new credit lines and dump savings into shares of GameStop in a stock market battle against short sellers and hedge funds. Read on for an easy-to-follow rundown of the situation—which, of course, changes with the volatility of the stock market itself.
What is a short sell?
One of the investment concepts at the heart of all of this brouhaha is that of the short sell. In stock trading, investors generally buy and sell stocks that they think are going to increase in value. However, in a short sell, investors are actually betting on a stock going down in value. If it does, they pocket the difference.
How does this work in practice? By taking a look at GameStop’s stock (GME)—the stock at the center of this story—you can get a good understanding for what’s going on.
Video game retailer GameStop has been on a steady decline for several years. More and more video game players are buying and downloading games online, and the pandemic only accelerated its slow demise. As such, many short sellers targeted its cratering stock price with their short positions, getting consistent returns.
The way a short works is that a short seller borrows shares and trades them, hoping to rebuy them later at a lower price and keep the difference. For example, if GameStop was valued at $10 and fell to $6 over a set period of time, the short sellers could buy back shares at $6 to return to the lender and keep the $4 difference.
Short sells don’t always work that way, however. If instead of going down the stock price increases, investors have to cover their bet by buying the stock at a higher price, losing money in the process. As such, more than many other types of investing, short sells can be big gambles with the potential for impressive losses or returns.
How were Redditors looking to exploit that short sell?
Perhaps it’s not too surprising that an internet forum populated mostly by male traders in their 20s and early 30s would have an affinity for videogame stocks and movie theaters; however, the Redditors on WallStreetBets were on to something when they chose to go toe-to-toe with giant hedge funds like Melvin Capital.
What internet users realized is that Melvin Capital was being overly aggressive in how it was shorting GameStop. Redditors figured out that by buying enough of GameStop’s stock (which was only at $17.25 a share at the start of the year), they could cause a spike in the value of the stock. As the price increased, short sellers would have to rebuy at a higher price, and, by setting their sell limit on hundreds of shares of GME at a high price, everyday people could really cash in.
The plan, as you can probably tell based on media coverage over the past two weeks on platforms like CNBC and the New York Times, worked. Especially thanks to trading platforms like the Robinhood app, which allows for fractional shares to be bought and sold, even as the price of GameStop began to grow, Robinhood users were able to leverage the trading app to continue driving the price higher.
When Elon Musk tweeted out to his millions of followers “Gamestonk,” the price spiked even higher. Owners of shares of GameStop who bought in at a little over $17 were seeing the price per share hit highs of $480 over the course of the week, meaning their shares increased in value an unheard of 2,700%.
What’s the impact of all of this been?
Aside from generating a lot of press and market volatility surrounding a few stocks, what is the overall impact of Redditors squaring off against Wall Street hedge funds? While larger indices like NASDAQ seem to be more stable today, there’s still no telling how the story will continue to develop as cries for users to “hold” their portfolios or buy into large dips continue to rack up comments and upvotes on WallStreetBets.
Ultimately, takes on the situation vary based on where your interests lie. Here are just a few takeaways from the last week and a half:
Some brokerages altered how investors can invest
One of the biggest backlashes from all of this is against brokerages that changed what securities retail investors could purchase amidst the meteoric rise of stocks like GME and AMC. These traditional restrictions hurt retail investors who tried to get in on the action by limiting how many shares could be purchased at a time of the volatile stocks.
Robinhood CEO Vlad Tenev claimed that part of the reason trading platforms such as his had to limit trade volume had to do with regulators and clearinghouses; however, many investors felt spurned by the decision and switched trading platforms altogether. Other online brokerages stopped offering fractional shares in the corporations, as well.
The SEC is monitoring the situation
The Securities and Exchange Commission (also known as the SEC) has vowed to protect retail investors whose portfolios were stymied by the restrictions on GME and AMC stock. In a report from CNBC, the SEC is reported as vowing to investigate whether or not the actions of these brokerages worked to “disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.”
Members of Congress are weighing in
It’s not often that senators from across the aisle so quickly agree about a current event, but in the case of retail investors, both senators Ted Cruz and Alexandria Ocasio-Cortez have weighed in on the situation and agreed that retail investors deserve to be protected.
Alexandria Ocasio-Cortez specifically had a lot to say about RobinHood’s practices following the spike—especially since more than half of RobinHood users owned stock in GameStop and were unable to sell their shares. She tweeted on January 28, 2021, “This is unacceptable. We now need to know more about @RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit. As a member of the Financial Services Cmte, I’d support a hearing if necessary.”
Senator Cruz quoted AOC’s tweet to show his support with the two words: “Fully agree.”
Retail investors have buoyed struggling businesses
One bright side to the massive showdown currently playing out in the stock markets is the fact that it has offered a bright spot for retailers to stave off some of the damage COVID-19 has inflicted upon them.
Particularly in the case of AMC, the added interest and value in their stock has been a necessary lifebuoy. Polygon reports that the “meme stock rally” wound up eliminating close to $600M in debt that the company held as the firms that held some of the debt opted to convert their holdings to stock. As such, even though the stock price has fallen in recent days, AMC has avoided a massive amount of debt, offering the company a chance to face another year as the success of a national vaccine rollout continues to be linked to their business.
The bottom line
If there’s anything to be gleaned from the past week’s news it’s that the stock market isn’t always connected to actual economic health. As internet users demonstrated, the market is not immune from manipulation—even if the stocks being manipulated belong to flailing businesses like GameStop and AMC Theaters.
While it’s easy to get caught up in imagining your life’s savings multiplying exponentially in a manner of days, it’s just as important to take note of how the stock prices have fallen in recent days. Many Reddit users claim that this is manipulation on the part of hedge funds, while others bemoan their losses and regret not exiting their investment when GME topped $400.
It’s worth remembering that although there’s much to be gained from the stock market, treating it as a casino rather than opting for safer investment strategies could blow up in your face just as quickly as it could make you rich. Consistency, rather than luck, is a much more prudent financial strategy if you’re really interested in buying your first stock.