A week ago, not many outside the world of investing would have even heard of a Reddit community called WallStreetBets. In the last few days, however, the community’s giant-killing act of almost toppling a successful hedge fund and subsequently disrupting normalcy in Wall Street has ensured that it can’t be that obscure any more.
It is being talked about all over the Internet, and cheered by those who see it as a typical David Vs Goliath story, one in which the underdog takes on a strong and powerful rival and thrives. Others see true democracy in action. And those in the conventional investing world worry about the entry of a new complication in matters of money-making. Amid all this attention and adulation, the community has added close to 5 million members in just a few days.
WallStreetBets’ overnight leap to stardom cannot be explained without talking about who or what its brand new admirers consider to be the Goliath in this story: a New York hedge fund called Melvin Capital. What Melvin Capital did was what hedge funds usually do — take short positions in stocks using a lot of borrowed money. A short position is essentially a bet on the price of a stock going down. Investors who take such positions do so by selling borrowed stock at the prevailing market price. The logic is: when the price falls, they can buy it at that lower price, thereby making a profit. They would then be able to return the stock to those who owned it in the first place.
But what if the price doesn’t fall but, instead, climbs and keeps climbing? That means trouble. And that’s precisely the situation Melvin Capital was forced to face when a bunch of retail investors in WallStreetBets decided, for some reason, to go after its short positions in a company called GameStop, a video game and consumer electronics retailer based in Grapevine, Texas. Their heavy buying of the GameStop stock not just caused its price to rise, against Melvin Capital’s expectations, but the latter found it difficult to cover its short positions, which it had to via the purchase of increasingly expensive stock, as the buying continued.
This retailer has certainly seen better times. That is more or less the import of analyst reports about GameStop in recent months. “As customer attitudes have shifted in buying digital media online, GameStop has suddenly found itself on the losing side of history,” one analyst wrote in December 2020. For much of 2020, its stock was trading at well below $10.
Out of sync
But as the WallStreetBets-Melvin Capital drama reached its climax in the latter half of January, the stock reached $325 (the price at which it closed on January 29), which is completely out of sync with the fundamentals of the company, if the analysts are to be believed. But, as a Twitter user put it, GameStop is “just a piece of rope” in the tug of war between WallStreetBets and Melvin Capital.
The hedge fund, after suffering heavily, closed its position in GameStop. It also got a lifeline of $2.75 billion from two other funds. It survives. There is no apparent reason to believe that the WallStreetBets had a specific dislike for Melvin Capital or, for that matter, affection for GameStop. But many members have recalled their painful memories of dealing with the economic troubles in 2008, something that they blame Wall Street for. One such message, addressing Melvin Capital, said, “You stand for everything that I hated during that time.”
WallStreetBets was started in 2012 by Jaime Rogozinski, a 39-year-old consultant in Mexico. His idea was to have “a place where sophisticated investors could swap tips about high-risk, high-reward short-term trading strategies,” says a 2018 article in Money.com. By this time, the investing ecosystem was starting to hear about this unorthodox community of retail investors.
Mr. Rogozinski himself had downplayed the role of his community as a source of business intelligence in an interview last year. He said, “Financial ideas? Perhaps. People look for them everywhere and WSB (WallStreetBets) is an extremely entertaining forum, so it’s entirely possible that people go for the entertainment and walk away with financial ideas.”
WallStreetBets has already given plenty of ideas to disruptors and plenty of worries to the establishment.