EXPLAINER-How retail traders squeezed Wall Street for bets against GameStop


Shares of video game retailer GameStop Corp surged nearly 700% over the past week as retail investors piled in to the stock, appearing to be urged on by bullish posts in popular online forum Reddit as opposed to any fundamental changes in the company's finances or prospects. GameStop's interstellar surge has sparked calls for regulatory scrutiny. - reuters

LONDON: A surge of retail stock trading over the last year lit the fuse that sent shares of GameStop Corp rocketing higher without a clear business reason, market watchers say, squeezing hedge funds that had bet against the video game retailer and other companies that were out of favor on Wall Street.

What is going on? Here are some answers:

BEHIND THE SURGE IN INTEREST OF RETAIL INVESTORS:

More individuals have invested in stocks during the COVID-19 pandemic, and experts cite a number of reasons. Lockdowns boosted savings, policy stimulus put cash into people's pockets, and extremely low interest rates drove investors to the stock market. Also, a proliferation of trading apps allowed anyone with a smartphone to buy or sell stocks for free.

Retail investors' participation in U.S. equity order flows increased to nearly 20% in 2020 from 15% in 2019, while orders from long-only funds fell to 6.4% last year from 9.7% in 2019, data from Swiss bank UBS showed.

Data this year suggests further growth. Online broker eToro said it registered more than 380,000 new users in the first 11 days of 2021, adding to the 5 million who used it last year, for example.

Retail investors are also buying stock options, the right to buy or sell shares at set prices without putting cash upfront. That takes their dollars much farther and can turbocharge share price movements.

WHAT HAS BEEN THE IMPACT OF THIS SURGE IN RETAIL TRADING?

Big U.S. technology companies were among the beneficiaries last year. Facebook, Amazon, Apple, Netflix and Google-owner Alphabet saw record inflows as their businesses benefited from lockdowns and their stocks soared.

With unprecedented stimulus and easy money policies from central banks, investors then shifted to smaller stocks, especially ones that got beaten down during the pandemic.

Market capitalization of world stocks surged to a record $88 trillion, a whopping $33 trillion jump from the March bottom. In the last few days, GameStop’s shares have jumped 1600%, with big gains also for shares of AMC Entertainment Holdings Inc, Blackberry Ltd, Nokia Oyj and others.

WHAT’S HAPPENING ON REDDIT AND SOCIAL MEDIA?

Online discussions about stocks on social media platforms such as Reddit, Twitter and Facebook are seen by many traders and analysts as fueling massive share price moves that cannot be explained by fundamental news or traditional valuation metrics. Retail investors have long discussed stocks on social media, but during the pandemic these forums appear to be gaining more influence. Investors pointed to discussion threads such as “WallStreetBets” on Reddit for driving the surge in GameStop.

Professional investors are paying attention. Dennis Dick, a stock trader in Las Vegas said he reads the site Seeking Alpha before work and keeps up to the minute by watching Twitter, but last weekend he also joined a group on Reddit "because I need to know what's going on."

HOW HAS THIS AFFECTED HEDGE FUNDS AND PROFESSIONAL TRADERS?

Massive share price swings for no apparent reason have caught Wall Street off guard. Short sellers, or investors who bet the price of a stock would fall, are getting crushed. Melvin Capital, a well-established hedge fund, took massive losses on its bets that GameStop share would fall.

Traders scrambling to cover these short positions and prevent further losses had to pay inflated prices, which added more fuel to the rally. Several traders told Reuters that this phenomenon -- the classic short-squeeze -- drew in still more retail investors hoping to ride the wave.

WHAT ARE THE RISKS?

With global stock markets surging since March despite the pandemic’s devastation of the real economy, investors and analysts are warning about asset bubbles. If markets turn, overvalued stocks will fall with them. Many trading platforms also offer loans to investors to buy shares and magnify their returns. In a falling market, that could wipe out people caught on the wrong side of the trade.

Reuters also reported:

Shares of video game retailer GameStop Corp surged nearly 700% over the past week as retail investors piled in to the stock, appearing to be urged on by bullish posts in popular online forum Reddit as opposed to any fundamental changes in the company's finances or prospects. GameStop's interstellar surge has sparked calls for regulatory scrutiny. Why?

MARKET MANIPULATION

U.S. law bars the dissemination of false or misleading information with the aim of manipulating investors into buying or selling securities, as seen during a rash of "pump and dump" schemes during the early 2000s dot.com boom.

Regulators are likely to explore whether Reddit was used in a similar way, after thousands of messages hyped up the stock and urged other investors to hold on to their shares or buy more.

"GME IS THE HOLY GRAIL," wrote one user on Wednesday, urging others to keep pushing the stock higher. "WE ARE STILL GOING TO THE MOON...ITS NOT TOO LATE TO BUY."

Jacob Frenkel, Securities Enforcement Practice chair for law firm Dickinson Wright, said the SEC would likely look at whether the messaging by investors holding the stock long-term and activists betting against it was manipulative.

"With federal prosecutors having become much more sophisticated in their cases over the years on securities trading... it is reasonable to believe that any SEC investigation could well have a parallel criminal investigation," he added.

The U.S. Securities and Exchange Commission said in a statement on Wednesday the agency was "actively monitoring" market volatility without offering specifics. The Southern District of New York, which could have jurisdiction over a criminal case, declined to comment.

STOCK EXCHANGE HALTS

Wild swings in GameStop's shares led the New York Stock Exchange (NYSE) to halt trading in the company several times this week. But lawyers said there was sufficient marketplace confusion to warrant a longer suspension.

On Wednesday, the Massachusetts state regulator, William Galvin, called on NYSE to suspend GameStop for 30 days to allow a cooling-off period. "This isn’t investing, this is gambling," he told Reuters in an interview. "This is obviously contrived."

Lawyers said the incident could prompt a broader review of share suspension rules.

"I could see the SEC encouraging the NYSE to put in place rules that might smooth such swings as a result of retail investment activity," said Marc Adesso, partner at Saul Ewing Arnstein & Lehr. NYSE declined to comment.

NYSE said it employed advanced technology to investigate suspicious trading activity, according to a representative.

RISE OF LOW-COST RETAIL BROKERS

The GameStop saga has again shone a spotlight on low-cost retail trading platforms which have allowed millions of ordinary Americans to trade stocks. Consumer advocates say retail investors are taking risks they may not understand and incurring hidden costs that are rarely fully disclosed. "So much of this trading has been fueled by broker de facto claims of 'free trading'... but that is false and misleading and the SEC should say that and stop it," said Dennis Kelleher, CEO of progressive think tank Better Markets.

The combination of accessible retail trading and social media could upend the market if not adequately policed, Galvin warned.

"It's diminishing the integrity of the marketplace and it’s putting individual investors at risk." he said.

- Reuters

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