If you have been keeping up with financial news lately or even just looked at Twitter, you are probably asking yourself a couple of different questions.
WallStreeBets? GameStop? Robinhood? Diamond Hands? Reddit? What does all this have to do with one of the biggest losses in Wall Street history? To understand how Reddit users beat the top hedge fund managers in the country, you will have to go back to the origins of the sub-Reddit and how its users approach investments. The subreddit known as “r/WallStreetBets” (also known as WSB) was started by a young entrepreneur named Jaime Rogozinski in 2012. Rogozinski, living on the East Coast and interested in stocks, started the sub-Reddit to talk earnings and other tips about the market. The community started very small and quickly developed a culture of unsafe or undiversified investors, investors who were not interested in index funds or more traditional methods of investing. By late 2014 to early 2015, WSB had begun to gain traction, surpassing over 5,000 users and developing a distinct community. YOLO or “you only live once” begin to appear alongside pictures of users losing money in the markets, sometimes in the 10,000s. Posts about suicide and joking about autism also became very popular on the sub-Reddit as well.
According to CNN Business, Jamie Rogozinski is “enjoying this from the sideline.” The subreddit itself has denounced Rogozinski and no longer welcomes his input.
Around this time Robinhood launches its first trading app on the iOS store. The San Francisco based company would go on to win awards in design and become the most popular trading app for users on WSB.
As the years went on, the messaging board began getting more and more attention. People like Martin Shkreli, former pharmaceutical executive, and Jim Cramer, host of Mad Money, saw the potential in the sub-Reddit. In 2017, the subreddit attracts more attention. Users on the sub-Reddit talk about how AMD, a computer chip manufacturer, is undervalued. This turns out to be correct giving the group of independent investors more creditability.
Around late 2017, Robinhood introduced options trading on their app. Trading stock options is a riskier form of investing since the trading is under contract and requires investors to buy into a stock that might later move in the opposite direction. This would have the investor in a bad position since he/she could be paying double or triple their initial investment. Many users on WSB got into stock options trading and lost a lot of money. One user on the sub-Reddit by the name “1R0NYMAN” lost nearly $300,000 using a Box Spread strategy, something many traders on Wall Street never use. Even his fellow Redditors warned him against it. After the incident, Robinhood banned Box Spreads from the app permanently. Additionally, there are many other horror stories on the app from WSB users. For example, one user made and then lost $700,000 in a 3-week window and another user betted against Apple a day before an earnings report and lost badly. These 3 incidents were reported or captured by Redditors on the subreddit and CNBC, MarketWatch, and many other financial publications. All of this was a result of the sub-Reddit and its risky attitude toward investing.
Take this trading attitude and fast-forward to late 2020. GameStop, the retail video game seller, is in trouble since the current market is showing that most games are bought online. Additionally, physical media is on the downturn, so the company is in serious trouble. The company reported at the beginning of 2020 that nearly 90% of its stores were closed due to COVID. Gross Margin had declined 270 basis points (bps) compared to the first quarter of 2019. Jim Cramer compared the company to Blockbuster. Ryan Cohen, the former CEO of the online pet food company Chewy, starts campaigning for GameStop to completely change its business model. Cohen believes it could become the Amazon for online gaming, and he gets a seat on the GameStop board.
Around this time, Robinhood is fined by SEC for misleading investors about the amount of money they were making. The company is fined $65 million but does not admit any wrongdoing on their behalf. The case can be found on SEC.gov under 2020-321.
In early 2021, the short squeeze of GameStop starts. There is optimism for the company as the new year begins since they have just got three new executives working to change the company for the better. The stock’s price increases 27% in a single day. The good news reaches WSB and the individual traders start buying, seeing an opportunity to make money and beat short-selling hedge funds at their own game. Citron Research and other firms like Melvin capital insulted the Redditors over Twitter saying they were “the suckers at this poker game.” This insult only fueled the fire as the stock would jump 51% in a day and had to be halted four times due to volatility. In the following days, January 25-27, trading had to be halted 14 times and WSB had gained 5.2 million subscribers. Moderators of the site had to shut down the subreddit for a few hours to catch up with the current price of GameStop. The stock of the company reached $483 per share. AMC would hit a ceiling at $19.88 per share.
On January 28, Robinhood stopped trading all stocks talked about on the subreddit. This caused the company to receive a lot of backlash from people on social media and even politicians from both sides of the political aisle. Both AOC and Ted Cruz called for Robinhood to be investigated. Other Senators and talking heads loosely claim that the traders are “foreign actors,” and Senator Elizabeth Warren called for the SEC to step in and investigate Reddit. The company claims it had to halt trade due to SEC mandates and clearing house requirements. Other trading platforms like TD Ameritrade also stopped trading the active stock, directly or indirectly causing the price to plummet. Still, the backlash was fierce and many on Twitter called to stop using the commission-free trading app.
The next day, January 29, Robinhood allowed investors to trade the halted stocks from the day before. The stock would soar back up to $413.98, a 113% leap from the day before. Many Redditors on the app held their shares and weren’t scared by the activity from the day before and it paid off. Users began posting their earnings and some of them donated to charity and other moral organizations. According to CNBC and The Wall Street Journal, Melvin Capital lost 53%, roughly $460 million. Additionally, reports from Yahoo Finance shows Citadel with a $2.75 billion loss. Hedge funds and other short sellers lost $60 billion in profits but seem like they are not going anywhere.
At the end of the day, this is a great David vs Goliath story and showcases the true power of the internet. However, unlike the original story, there are some downsides to this: Melvin capital just got a $1.5 billion injection, the SEC is watching online chatrooms now, and most likely more regulation is coming. This seems to be a small victory in a much larger story, but we will have to wait and see the outcome.
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