By now you’ve surely heard of the David and Goliath battle which has played out over the past few weeks between WallStreetBets and multiple corporate hedge funds. The ability of amateur investors to create incredible change within the market while costing hedge fund investors billions of dollars came as a shock to many, and has the potential to set a new precedent for individual and corporate investors alike. While the GameStop saga may be petering out, questions are raised about the future impact this event will have on the Stock Market.
Since COVID-19, the percent of individual and retail investors on Wall Street has been steadily increasing. With easy to use investment apps like RobinHood and Acorn, getting into the market has never been easier. In fact, RobinHood gained 3.1 million new users in early 2020, nearly half of them being first time investors. And these new investors aren’t going at it alone. While only now given the spotlight, r/WallStreetBets has been letting investors communicate with each other en masse since 2012.
Traditionally on Wall Street, the ability to move the market or particular stocks related directly to the capital behind large investment firms and wealthy individuals. What happened with GameStop reveals that large numbers of well coordinated individual investors can move the market similarly to how hedge funds and well capitalized Wall Street firms have in the past. Going forward, what this means is that there can be increased market volatility and a new interest from large hedge funds in monitoring social media platforms. We’ve already seen from GameStop that large Wall Street firms are learning to take into account the movements of retail investors so that they can capitalize from or counteract major events like this in the future. Jason Reed, a finance professor at the University of Notre Dame told CNBC that “to some degree, this herd Reddit movement is going to continue.” But what does this influx of retail investors mean for the health and stability of the market moving forwards?
For starters, let’s answer the question, “Where are these investors coming from?” The demographics of the rising retail investors are millennials and gen-Zers, who because of the pandemic, have extra time on their hands. Stimulus checks and easy to use trading apps made it easy for first time investors to join the once elite and exclusive world of stocks. According to CNBC, trading stocks was among the most common uses for the government stimulus checks in nearly every income bracket. But, being inexperienced, these investors often don’t know how to watch the market. This is where the herd mentality comes into play. WallStreetBets capitalized on users with promises of “GME to the moon”, orchestrating mass movement in the market by simply convincing a majority of its members to invest in the same stocks. For those who sold early, it worked out, but for those still holding, it will end in disaster. The reckless abandon with which new retail investors are hopping onto trends stems from many reasons, but perhaps the most basic is the fear of missing out. People sharing on social media and on other platforms see their seemingly ballooning shares makes other investors anxious to buy in, but basing investments on speculation and hearsay has the potential to dramatically decrease the percent of investment profitability, both long and short term. It’s a dangerous game of follow the leader, and you’d just better hope you don’t fall off a cliff.
If retail investors continue to seek to cause upsets in the market like what happened with GameStop, large investment firms and hedge funds may be more hesitant to short stocks after witnessing the heavy losses from prominent names like Melvin Capital. This may not be a good thing, as studies have shown that short selling can actually have positive impacts on maintaining healthy and efficient capital markets. Short selling also helps strengthen the market by exposing which companies’ stock prices are too high, according to Investopedia.
Only time will tell if the GameStop saga set a new standard on the investment practices of retail investors, and whether or not it was an isolated event. While increasing the amount of investors is good to ensure the market remains vigorous during the pandemic, risky and irresponsible investments could do damage to both personal and corporate investors, and eventually to the overall health of the market.