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This article is part of the FT’s Runaway Markets series.
An army of amateur traders has launched a siege on Wall Street that has rocked the markets and left seasoned hedge funds in shock.
This new legion of day traders, equipped with free trading platforms, liquidity and boredom, has set their sights on a growing list of listed companies in the United States in recent weeks.
GameStop, a game retailer whose shares were sent by gangs of traders coordinating moves on Reddit, finds itself at ground zero in a battle that has shown these destitute investors are no longer just a side spectacle.
The impact is now spreading to other stocks and triggering sophisticated hedge funds that pride themselves on their superior skills to navigate the markets. Alarm bells are ringing among investors and former Wall Street regulators who see worrying parallels to the pump and dump systems that have proliferated in the dotcom age.
“People who are hurt because of these things. . . do people who buy inflated prices think they’re on a rocket on the rise and that in fact this rocket is going to crash, ”said Steve Cutler, a Simpson Thacher partner and former head of the application of the Securities and Exchange Commission.
Years before Reddit was founded, day traders traded stock advice on sites like RagingBull.com and Silicon Investor. An online tipster, known as Tokyo Joe, became so popular that he launched a website, attracting thousands of paying subscribers. He eventually caught the attention of securities regulators in the dotcom boom and agreed to pay $ 755,000 to settle a regulatory prosecution.
Market watchers now see similarities to that time. GameStop shares jumped 145% to peak on Monday, after a dizzying rally on Friday, as Reddit users said the company and another suddenly beloved stock – BlackBerry – were going “to the fucking moon.”
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In GameStop’s frenetic trading, the Redditors had a clear goal besides just increasing their favorite bet: they wanted flush out two hedge funds who were executing negative bets on the stock.
Their persistence prompted a bailout for one of these funds Monday, while Citadel and Point72 Asset Management agreed to inject $ 2.75 billion into Melvin Capital – a fund targeted on Reddit for several months. The other’s founder – renowned short seller Andrew Left of Citron Research – last week withdrew from any further comment on GameStop, saying his opinions had drawn abuse online by a “mob.”
“These are not idiosyncratic events,” said Andrew Slimmon, portfolio manager at Morgan Stanley Investment Management. “It reflects the fact that you have a growing cohort of people moving the market. I would be very careful short circuit [certain] businesses because the cash is there and flowing. ”
Analysts note that Americans will likely receive $ 1,400 in stimulus checks from the government in March, some of which could end up in stocks.
Reddit’s grossly pleasant posts, many of which are from users whose names are too rude to print, are likely to attract the attention of regulators in Washington even if cases prove difficult to bring, d ‘said. former enforcement officials of the Securities and Exchange Commission.
John Stark, a speaker at Duke Law who previously headed the SEC’s Office of Internet Law Enforcement, said committee staff would likely investigate whether Reddit users were making false statements or deceptive to entice other investors into a stock.
“There’s a whole bunch of investors out there who really don’t care about the intrinsic value of a business,” he said. “They just care if there is someone else who will pay a higher price.”
The SEC is also likely to investigate whether users are being paid for their referrals by companies or other organizations looking to move stock. Any investigation could take months – or even more – involving assignments of user IP addresses and brokerage trading records, Cutler said.
The commission can also intervene earlier if it sees blatant market movements or suspects manipulation by suspending trading of a stock or seeking temporary redress from the courts. Mr Cutler noted, however, that suspensions were often unpopular because they left investors who had jumped into the stock stuck in the stock.
The SEC declined to comment.
Options are central to the success of retail investors in moving markets, with the use of instruments that allow traders to bet on the direction of stock prices being amplified by commission-free websites such as Robinhood. Overall, this has forced large brokers to buy stocks to cover their own risk, helping to strengthen the influence of day traders who typically have much less financial clout than their established rivals on Wall Street.
Chris Murphy, co-director of derivatives strategy at Susquehanna International Group, said the rise in prices of other heavily shorted stocks shows that activity is spilling over into the US stock market. The 50 most frequently sold stocks by hedge funds have outperformed the S&P 500 so far this year, according to Goldman Sachs.
“If you’re an institution and you’re strapped for stocks, you can look at the GameStop situation and think it’s not worth the risk, and hedge your position,” Murphy said. “And then you have shorts that are covered everywhere.”
Wall Street analysts on Monday updated institutional clients, including pension funds and hedge funds, with lists of stocks they believe could face the same storm as GameStop and BlackBerry.
“You had a world where everyone was watching [CNBC presenter] Jim Cramer on TV and he was talking about something and [the stock] would go crazy, ”said a trader for a major brokerage in New York City, who requested anonymity. “You are now in a world where this is coming from a lot of social media platforms. In many ways it is much more democratized. . .[but]it’s harder to understand how real this is. “
Additional reporting by Patrick Temple-West and Robin Wigglesworth
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