What lessons can be drawn from the standoff between the WallStreetBets community and the hedge funds on Wall Street, whether retail traders can fundamentally change the market in the long run, and whether decentralised exchanges would solve the problem of trading halts — for ForkLog, Exante co-founder Exante Anatoly Knyazev answers these questions.
The GameStop saga has already entered history and earned a place in Wikipedia. a book will be written and, perhaps, a film will be made in Hollywood. The plot is impressive: traders on the Reddit forum decide to punish the predators from hedge funds that used to rake in billions by tracking down weak companies and devouring them. But what was it really like?
The Reddit/WSB guys noticed a large number of short positions in GameStop stock, significantly exceeding the number of shares available for trading. Then 2.7 million group members (which soon grew to 8 million), motivated by both revenge and profit, over several weeks ramped up their buying, reaching dizzying heights. From a low of $18.84 at the start of the year they at one point rose to near $500.
This was like [simple_tooltip content=\”The civil protest in New York, which began on September 17, 2011. Participants occupied Wall Street to draw attention to the ‘crimes of the financial elite’ and call for structural changes in the economy.\”]Occupy Wall Street[/simple_tooltip], only cooler: the vengeance struck not the hearts of bankers (as they are said to be heartless), but the wallets. As a result, hedge funds were forced to buy back shares at inflated prices, locking in losses. The legend among them, Melvin, lost half of its capital; other major players, such as Point72 and Citron, also reported huge losses. Day-trader Dave Portnoy was at the forefront of this revolution:
One of the leaders of WallStreetBets once wrote: \”The only way to win a rigged game is to rig it even more.\” Did he realise how deeply he would be right?
Pump and dump
The GameStop story, which we witnessed with our own eyes, is in some respects a classic on the pump-and-dump scheme. And in this situation, it seems brokers saved their clients from themselves, though this came at the expense of those clients who had already bought the shares. In other words, if there are no new buyers, the shares fall, and the last buyers are left holding them.
Robinhood co-founder explained the trading halt to Elon Musk
Doesn’t it seem odd that the falls in prices were not so sharp against a near-total ban on retail traders? Purchases continued — this suggests that the substantial price move in GameStop was not driven by retail traders on Robinhood and Reddit.
GameStop has about 69.7 million shares outstanding. Nearly 180 million shares traded on both Monday and Tuesday. This means that on average each GameStop share changed hands about 2.5 times on each of these days. Shares were bought and sold, and the fact that the crowd of retail traders was not overwhelmingly on one side confirms this.
Why did brokers halt trading? To deliver a smooth product, brokers expose traders to the full position. Yet the backbone of the U.S. financial markets has long operated on a \”T+2\” settlement cycle. That is, a broker buys the shares for a client, but the client will only receive them two business days later. And the money must be paid on the second business day as well.
Brokers were obligated to settle with the U.S. depository for client positions within two days at the price at which they had transacted. As the rally continued, the depository grew worried that the broker or clients might reverse and fail to pay that price. Brokers did not expect to have to post funds for all the shares over those two days. As a result — Robinhood was forced to borrow $1 billion, then another $2.4 billion.
What lies ahead for brokers’ business model? The wave of outrage did not fail to reach the SEC and other U.S. regulators. The online-brokerage model, which presumes routing client orders to market-makers, came under scrutiny. On the one hand, brokers must guarantee best-execution; on the other, the market-maker may trade against its clients.
How the founders of Robinhood lured millennials to the stock market and made money selling their data to the sharks on Wall Street?https://t.co/athwnW7yRZ
— ForbesRussia (@ForbesRussia) August 29, 2020
Who’s new on the scene
After a substantial drop in GME, a wave of pumps rolled across the markets, but they did not end in success either. First traders tried to pump the XRP token, to which U.S. authorities had raised questions. The token rose by 60%, but soon began to fade amid heavy selling. Clearly, traders were used as cannon fodder to dump their assets at the best price.
Notably, the tale with silver was no less epic. On Reddit a hashtag #silversqueeze circulated, urging people to buy exchange-traded funds linked to the metal because prices were artificially suppressed. Indeed, prices rose to eight-year highs, surprising even seasoned participants — the depth of liquidity in the silver market is far greater than for third-tier stocks, though still far less than for Bitcoin. It is worth noting that trying to \”punish\” hedge funds will not work; many of them hold long positions in this asset. Moreover, in recent days it has also been shedding positions, retreating from its highs.
DeFi
Could decentralised exchanges solve the problem of trading halts? The answer is surprising: yes and no. For example, Synthetix moved silver trading to the weekend (the sXAG token, operating on Chainlink oracles). However, the exchange paused trading almost immediately, as the influx of traders took on a position too large for Synthetix, which on Monday caused the exchange to incur losses.
Game Over for GameStop
Short selling can be viewed differently: a signal that something is off with a company\’s business model. All the firms targeted by shorts shared one trait — they had been successful in the past, but not in the present. At some point they ceded market leadership to those who understood demand and offered a better product.
However, if the story as depicted by the media is accurate and the players were only Robin Hood traders, one might suppose they can stay united, launching further attacks on the shorts, and real short squeezes lie ahead. Do you believe it?
The reality is that the financial markets have drawn many newcomers who received government cheques and decided that trading was almost the same as the GameStop store game. But the market has made clear that nothing in the food chain has changed: predators remain predators (though some incurred losses), and the small fish remain prey (though luck smiled on some).
Lessons for the day ahead
- A local high-risk play in third-tier stocks or near-bankrupt companies often ends as abruptly as it begins. You never know the moment the market will turn.
- A high-risk game is likely to leave retail traders without a shirt sooner rather than later.
- If you do join the hype despite all the above, remember that a successful trader is not the one who saw the price rise, but the one who managed to profit from it.
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