Unless you are living under a rock, you may have noticed that all everyone is talking about this week is the subreddit WallStreetBets, GameStop stock rise, Hedge Funds filing for bankruptcy, and Robinhood’s questionable actions.
What happened?
Wallstreetbets is a Reddit sub-group, or subreddit, of 6+ million people (retail investors), who all participated in a plan to “legally” steal from the rich. A Hedge Fund manages investments for the rich. They have minimum $200,000 salary requirements just to join and they are popular with millionaires and billionaires. They employ multiple strategies to make money for the rich, including shorting stocks.
What does shorting a stock mean? To short a stock, you need a margin account. Webull and Robinhood offer these types of accounts with their premium memberships. The premise of shorting a stock is that you are assuming (placing a bet) that the stock price will go down. Hedge Funds were shorting GameStop, AMC, Nokia, KOSS, and several other stocks since they have largely went down in value over the past 1-3 years, especially with COVID.
Typically you buy a stock, wait for the price to go up, then sell it to make money. Shorting a stock is the opposite as you are betting against the stock. You want the price to go down when shorting a stock. Here is a quick example on how shorting works. You borrow a share of GameStop worth $5 and immediately sell it for $5. You need to return the share at some-point because you don’t own it. The stock price goes down to $3 and you buy it with the $5 you made from immediately selling the borrowed share. You give the share back and you keep the $2 difference. The opposite happens if the stock price goes up. Hedge Funds who short stocks will lose money if the stock price goes up.
Wallstreetbets took notice on what these hedge funds were doing and millions of people (retail investors) decided to heavily invest in GameStop, AMC, and other “failing” companies to raise the price, causing institutional investors and hedge funds to lose money. On the plus side, this caused many people to suddenly become millionaires within a few days. On the downside, hedge funds lost billions of dollars and at least one had to file for bankruptcy. People’s lives were affected.
Why is shorting bad?
When large institutional investors like hedge funds decide to short stocks, they can easily cause a company to go bankrupt. Hedge funds have so much money that they can easily manipulate the market with their purchases and sales. The hedge funds targeted by the subreddit Wallstreetbets were causing failing companies to fail faster, ultimately leading to a potential demise of AMC (movie theaters) and GameStop (brick and mortar video game sales). This was also causing retail investors like you and me to lose what we may have invested in GameStop and AMC. The shorting strategies employed by hedge funds cause the rich to get richer and the poor to get poorer while hurting the economy by forcing companies to go bankrupt. Wallstreetbets gave institutional investors a taste of their own medicine by beating them at their own game.
What about Robinhood?
On the morning of January 28th, 2021, Robinhood froze the ability for retail investors to buy GameStop, AMC, KOSS and other securities due to the volatility of the market. You can still sell (to institutional investors like hedge funds), but you can’t buy. Webull and several others quickly followed suit and restricted trading on the same stocks. They had no choice in the matter. In order to meet their financial duties and regulations, they had to take our ability to buy those specific stocks. With thousands of people joining Webull, M1 Finance, and Robinhood to get in on the Wallstreetbets action, the brokers couldn’t keep up.
So why are so many people mad at Robinhood and not the other brokers who also limited the ability to buy these stocks? It is speculated that Robinhood colluded with Citadel, who partially owns Robinhood, in freezing the purchases of these stocks so that Citadel and institutional investors can short the stocks and get their money back. After all, Citadel loaned money to one of the hedge funds that were losing money in GameStop. In addition if you owned GameStop, Robinhood may have sold your stock for you, without your permission, when GameStop was at its lowest price yesterday. They claim they did this in the interest of retail investors to prevent them from losing too much money in this volatile market. The way Robinhood handled the situation caused record downloads for other brokerages. Webull saw its largest jump in the app store going from #8 to #3. Millions of Robinhood investors jumped over to Webull, M1 Finance, CashApp, and others. If you are interested in joining other brokerages, check out my referral links below.
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As a Robinhood user myself, I understand why Robinhood and other brokers froze the purchase of those stocks and I know why they had no choice. However I do not understand why Robinhood thinks it’s okay to sell stocks on your behalf. With a class action lawsuit filed and politicians like Alexandria Oscar-Cortez and Ted Cruz getting involved, regulators have taken notice.
What now?
What happened in the past week has shined light on the flaws of the stock market and our economy. It has raised the eyebrows of law makers and has challenged ethical standards. It is likely that this event will result in new laws limiting both shorts for institutional investors, and huge sudden gains for retail investors. This also proved that a decentralized system like Bitcoin is much more robust against these strategies, causing Bitcoin (BTC) and other crypto’s to shoot up in value over the past 2 days. Bitcoin alone went from $29,000 yesterday to $38,000 earlier today.
As for Robinhood, I wouldn’t count them out yet. They lifted the freeze on stocks this morning (with limitations). Webull and other brokerages supported Robinhood’s decisions and CEO Vladimir Tenev’s remarks on CNBC and Bloomberg. Both Vladimir Tenev and Webull’s CEO’s Anthony Denier spoke out against the misinformation and the misunderstanding of financial mechanics of the stock market and brokerages. I am sure there is more to the story than we understand. What do you think about all of this? Comment below.
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