Gamestop, memestocks, and the revenge of the retail trader

Gamestop shares are set to rally 70% this morning when trading starts, and AMC shares opened up 300%, extending a run that has perplexed market observers, irked hedge funds, and generally made crypto's recent gains appear soft and weak.

Being a retail trader is mostly being a sucker, hoping to best the markets while lacking the infrastructure, access, and information that professionals enjoy. Hell, most professional fund managers that regular folks can invest in fail to beat the market. That's one reason why index funds and other passive investments that merely track aggregate performance have grown so much in recent years; why pay more to have someone make you less money than simply making the same returns as the S&P 500?

Things have changed some in recent years. Robinhood blew up the trading fee economy, and now along with a host of similar companies - Public.com with its social focus, Freetrade in the UK, and so forth - has made retail investing far more accessible than it was before to more folks. And we're all trapped inside. And a rude, jokey Reddit forum has gone from in-nerd joke to front-page news after its users started to push their weight around.

It's something that was noted by none other than the founder of Reddit Alexis Ohanian who shared some thoughts on Twitter.

And it's a perfect storm at a time when lots of people are hurting, interest rates are so low, inescapable student loan debts loom, and every major institution has caught Ls during a /global pandemic/ over the last year. This is something to believe in.

- Alexis Ohanian Sr. 776 (@alexisohanian) January 27, 2021

It's an old saw that back in the dotcom boom traders would congregate in chat rooms to share tips, lie to each other, and try to pump their own equities higher. That all still happens. But what has changed is that the combination of mature social platforms and free trading has at once boosted access to the public markets while Reddit and other online congregation points have provided a simpler way for retail investors, the hoi polloi, to fuck around and make other people find out.

Again, Ohanian's thoughts on this resonate.

A couple hundred thousand years of evolution conditioned us to believe in and rally around the immediate tribe around us. The idea of an institution' - a faceless, nameless entity we just have to trust - is actually pretty foreign to our species," the venture investor wrote on Twitter. I know they're all random people on the internet' but there's a lot more empathy and community there than people realize. It's why I've been saying for 15 years that (online) community is still massively undervalued."

This is what has happened with Gamestop, a company that until recently was unnotable, and stuck between a physical retail footprint, the pandemic, and its customers increasingly preferring digital game purchases. It was worth around $4 per share last summer. It started 2021 worth around $18. Now it's $147.98 after rising 92.7% yesterday, and is up $69.02 this morning, or 46.6%.

How did that happen? No, the company did not get suddenly, radically stronger in short order. Instead, a coterie of Reddit users realized that Gamestop was shorted by more than 100%. That means that investors had bet more shares than existed in the company that it would lose value.

And mostly this would have been fine, a quirk of the market; other highly-shorted stocks can see a majority of their shares sold short, but to see a short-percentage of greater than 100% was eyebrow-raising.

Then came the wager: If big investors had bet more shares than Gamestop had in existence that it would lose value, what would happen if lots of individuals investors - retail interest, as they say - started buying the stock? That might drive its value up, forcing the hedge funds and other big capital pools to decide whether to hold onto their negative bet and take strong paper losses as Gamestop rallied, or cover their short, buying the stock at a higher price than they initially paid for it, losing money. Covering shorts would require buying the stock at high prices, perhaps boosting its value yet again.

It's the wildest short-squeeze we can recall.

There's always tension between short-sellers and investors who prefer to make positive wagers. Indeed, shorts are generally hated and the term perma-bear, slang for someone who is chronically worried about the price of assets to the point of distraction,¹ is often levied at them.

But a boom in retail investing and social platforms allowing the congregation of disparate individual investors can do quite a lot, it turns out. So, users of the WallStreetBets sub-Reddit started buying Gamestop. And they kept doing so, pushing its price higher and higher.

The result was that big money got smacked in the shorts, literally. CNBC reports that short-sellers have lost more than $5 billion so far thanks to Gamestop's rapid appreciation on the back of becoming an internet meme.

But the tug-of-war between professionals betting that Gamestop is not worth its inflated price, and that it will fall, is not over. Short interest remains high. So, even if some pro investors have cried uncle and exited their trade, the retail revenge on the so-called smart money is hardly a sure thing; what those excitable individuals may have done is merely set up a more enticing short position for hedge funds than had existed before.

Gamestop has a lot further to fall from over $140 per share than it did from $18, say.

Of course no one knows what will happen today. The investors who have taken out more short positions during the rally are set to eat their own ties this morning when Gamestop opens higher. Perhaps they will hold, and eventually their short bet will pay off. Or perhaps retail will be able to keep rallying Gamestop until, well, no one really knows.

But while most folks have their retirement accounts in investments so boring you've forgotten their names - Fidelity Freedom 2060 Fund, or what have you - small-time investors are sticking it to the man. This is the political war underneath the trading scrap. Retail is generally said to be mad at being pushed around, front-run, and generally speaking operating as second-class investing citizens. The Gamestop gambit is, to some degree, revenge.

Not that it will matter, per se, in the long-term. Large investing groups will still crush retail, having access to better information and tools and the like, as we mentioned up top. But today, at least, those same concerns are going to start the day with huge paper losses on their Gamestop shorts.

And that's hilarious, because the company is obviously overvalued and individuals simply do not give a fuck.

1. I, Alex Wilhelm, am like this before coffee.