Investing

Redditors Squeeze Out Professional Hedge Funds

As in many states gambling remains restricted, bet puns in those states seem to have found a perfect alternative. The work-at-home environment has inspired many to start investing as bank accounts yield close to nothing, while financial markets reach for all-time-highs. In this ultra-bullish environment small retail investors become increasingly risk-thirsty in their pursue for profits.

Broker platforms across the world have had millions of new subscribers since the start of the corona crisis. The corona sell-offs seemed as the perfect opportunity for beginners to step into the exciting world of investment. However, many lack the financial capacity and understanding to make thoughtful and risk-avoiding decisions. The Reddit board r/wallstreetbets have found the ultimate way to overcome this problem: organized speculative attacks against heavily shorted stocks. Initially the board was infamous for harboring self-proclaimed financial experts and ultimate risk takers, who suffered from severe confirmation bias, which tried to push-up their own portfolio stock picks. However, in 2020 the board seems to be invincible, after the corona dip in March many WallStreetBets picks have seen double-digit growth. From Tesla to Nio, and Novavax to Moderna, the Reddit experts outperformed professional financial guru’s in a tremendous way.

Redditors Triggered Unprecedented Amounts Of Short-Squeezes

Lately, financial markets have reached new highs and as rational investors started hedging some of their investments, the Reddit experts found a way to organize themselves. Under-performing companies like Gamestop (GME), Blackberry (BB) and AMC Entertainment Holdings (AMC) which were heavily shorted by private hedge funds were targeted. The problem with shorting a stock is that shorts have to hold enough reserve liquidity to cover positions if the price shoots up. This is exactly what happened, in a battle of Reddit investors versus shorting capital funds a vicious cycle of so-called “short-squeezes” started. When shorting a stock, a short sells a stock of someone else for a certain price and makes the commitment to give it back later. The short speculates on a drop of the stock in the future, effectively lending the stock from someone else. However, a stock can only go down 100% but can go up infinitely. A short has to maintain a certain level of liquidity to prove it is able to buy the stock back even when the price of the stock rises. When a stock rises to much higher levels, despite the short’s expectation, shorts will have to stop their losses and cover their position. However, by doing so the shorts push the price to even higher levels as speculators against the shorts have already pushed the price of the stock up.

This is exactly what happened the last few weeks, and it has gone to extreme levels. As shorters immediately sell the stock they lend, it could can end up to someone who again can lend it out to a shorter. In this way the short interest, the percentage of the float that is being shorted, can rise above one hundred percent. This was the case for game retailer Gamestop (GME) which already had a short interest above one hundred percent since the start of the pandemic when it had to close much of its stores. The stock is up 13424 percent from their April low of 2.57, however, there is no fundamental reason for this surge. It is all speculation, apart from the involvement of Ray Cohen who bought himself a 9 percent stake in January, the entrepreneur is known for his success with pet supply company Chewy, Inc. (CHWY).

Figure 1 – Gamestop (GME) stock chart in January

AMC Entertainment Holdings (AMC), Blackberry (BB) and multiple other companies saw their stocks surge to irrationally high levels, all as a result of pure speculation. It is waiting for the interference of the Security and Exchange Commission (SEC) as these rallies all lack fundamental reasons for their recent surges. This can be hardly seen as financial stability and proves yet again the over-liquidity of financial markets at the moment, which are the result of trillions of governmental stimulus and quantitative easing of central banks. This unhealthy search-for-yield attitude is a trend that started long before the comical stock market takeover of the Redditors from WallStreetBets. What needs to be done is unclear, however, classical economic and fundamental explanations for current market behavior are long gone. This latest trend is a symptom of increased risk taking behavior within the financial sector. It are not exclusively the Reddit puns who take on more risk.

Where this trend ends is uncertain, however, the FED’s bazooka has proved yet again to be extremely effective to boost asset prices. It is not adviseable to follow all the WallStreetBets picks, even though they have proved to be perfectly able to boost their portfolio’s with risky call options. The OCC, the world’s largest equity derivatives clearing organization, announced that it set new annual cleared contract volume records for the U.S. exchange-listed options industry in 2020, up 80.9 percent from a year ago. The surge in amount of options traded has been led by small retail investors, like the ones from WallStreetBets.

Figure 2 – Small retail investors lead the leveraging trend

Where this trend will end is uncertain, however, The Golden Investor thinks that a higher volatility can be expected now markets become increasingly disconnected with reality. Therefore investors should consider buying into high volume profiting stocks like Flow Traders (FLOW) and Virtu Financial (VIRT) that both benefit from large swings on financial markets. Despite the months of slow and steady declines in gold prices, The Golden Investor stays long on gold and silver. Especially gold miners seem to be cheap at these levels, considering that the prices of gold and silver remain highly elevated and aren’t likely to really drop in the current low-yielding environment. Even though safe-haven demand has diminished over the course of the last months, gold stays a good alternative investment to all asset classes. As for the Redditors among us, the recent upward trend has been a steady and fast rise up, however, over-leveraging bets is the fastest way to lose money when markets fall. For now, the Reddit puns have proved their point and are the moral winners in their fight against the financial Goliath.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.

Bibliography

  1. https://www.theocc.com/Newsroom/Press-Releases/2021/01-05-OCC-Clears-Record-Setting-7-52-Billion-Total
  2. https://www.marketwatch.com/story/a-surge-in-options-trading-is-pushing-around-the-stock-market-and-bringing-back-memories-of-the-dot-com-bubble-11611618636

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