The GameStop Revolt Has Just Begun. Get Ready. | Barron''s

The people fueling its insane rise made fun of themselves and readily acknowledged that they were involved in a “stupid” experiment to see if several thousand nobodies could take on Wall Street and win.

They won. The strategy wasn’t profound: “I’M HOLDING THIS ONE OUT EVEN IF IT COSTS ME EVERYTHING,” Reddit user atomsej wrote on its popular WallStreetBets forum.

Investors can ignore atomsej—even if the all-caps writing makes that hard—and stay out of GameStop (ticker: GME). But the trends involved aren’t going anywhere and are already having a ripple effect. Understanding the changes will be critical to playing the market, even for those who aren’t involved in the online wars over stocks.

Read more:

• Selling GameStop Was a Flop. Options Are No Slam Dunk.

• Why Did Robinhood Stop GameStop Trading? Everything to Know.

It is remarkable that such a big story starts with such a seemingly insignificant stock. From 2017 to last summer, GameStop shares fell to $4 from $25, yet there were glimmers of hope along the way. Michael Burry, famous for calling the mortgage bubble before the financial crisis, and Chewy co-founder Ryan Cohen disclosed stakes in 2019 and 2020, respectively. Despite skepticism from sell-side analysts, retail investors on forums like Reddit took notice, pointing to Cohen’s success beating Amazon.com in the pet-food business. GameStop announced that it would add Cohen and two other former Chewy executives to its board of directors earlier this month. It also announced holiday sales that largely disappointed analysts. That’s when things got weird, and the stock began to surge.

“ We were all making money together. People paid off their student loans...and their houses. ”

— Brandon Luczek, a 28-year-old electronics technician for the U.S. Navy

Users on WallStreetBets coalesced around the stock, countering the huge short interest that had massed against GameStop. The retail investors—some of them taking advantage of government stimulus checks—supercharged the trade with wildly bullish options bets. What started as silliness tapped into a populist movement that downloaded the spirit of Occupy Wall Street directly into millions of smartphones and, from there, into the plumbing of the world’s financial markets.

The new power of retail investors is a “change that is not going to go away,” said New York University professor Aswath Damodaran. “And that’s shaking up traditional portfolio managers, because they’ve lost control of the process.”

Here are the factors that drove the rally and that could affect the market well into the future:

RETAIL RENAISSANCE

In the past year, more new investors have opened accounts at brokers than ever before. U.S. brokers added at least 10 million new retail trading accounts, and a shift to zero trading commissions late in 2019 unlocked a wave of activity that dwarfed even the wild days of the dot-com bubble. Early into the coronavirus lockdowns, when people had little else to do and no major sports to bet on, trading activity started to surge and has not subsided, even as the economy has gradually opened up. Average daily trading at the biggest retail brokers hit a record of 6.6 million a day in December. This month, it soared again, to 8.1 million, according to Piper Sandler analyst Richard Repetto. On Wednesday, equity volume was triple the average day in 2019.

Retail investing has always been a small fish amid the hedge funds and other large institutions that tend to dominate trading. But that’s changing. Before the pandemic, retail trading made up 14% to 15% of equity volume; now, it’s consistently making up more than 20%, Repetto estimates. When that energy is concentrated on just a few stocks, it can make a difference—and in the case of GameStop and several-other bottom-dwelling names, it caused a startling shift.

MORE OPTIONS

Daily options trading has more than doubled since 2019, led by retail investors who can get it free on platforms like Robinhood. As of this month, small buyers account for about twice as much of the options volume as the big and midsize players, according to Deutsche Bank.

In some ways, options live in their own world—like a leveraged side bet on a stock. But they can also have an enormous impact on the underlying stock itself. Market makers who execute options trades have to hedge by buying the stock itself, often in large volumes. That action can cause the stock to rise even more.

The quick score of a bullish options play can be appealing to quarantined day traders, fulfilling both an emotional rush and a financial need—even though most options expire out of the money, making them worthless.

“We are stuck at home, and we are isolated and we are all scared, and a lot of us are hurting for money or struggling, losing employment,” said Austin Wynn, who runs a trading group that gathers on Facebook and the social-media site Discord and plays stocks like GameStop. “And I think it fulfills the high—as much as it may also fill the financial piece for a while.”

GETTING SOCIAL

Making a big bet is easier when all your friends are doing it, too. WallStreetBets began the year with about 1.7 million members and has since surged to more than six million members.

Groups of traders have targeted single stocks before, but never with the velocity and enthusiasm that they embraced GameStop.

“It’s very much a community thing,” said Brandon Luczek, a 28-year-old electronics technician for the U.S. Navy who lives in Virginia. “We were all making money together. People paid off their student loans, people paid off their houses.”

“It definitely felt like I was a part of something big,” Luczek said. He made tens of thousands of dollars on GameStop trades, including as much as $46,000 in a single day by using options.

Along with sharing screenshots of successful trades, the forums are infused with pop culture, profanity, and over-the-top doctored photos.

SHORT ATTACK

It hasn’t all been fun and memes, though. While this new group of traders has adopted a celebratory tone, they also have an us-versus-them mentality. The “them” in this case is whoever might qualify as a Wall Street insider. The gang’s antipathy focused on one group in particular: short sellers targeting stocks they like.

Shorts borrow shares of stocks they expect to fall, with the expectation that they’ll be able to buy them back at a lower price and return them to the lender at a later date. But when stocks start to rise, short sellers are under extreme pressure to buy, because they need to cover their positions and they don’t want to have to buy at even-higher prices. As short sellers panic, the buying pressure grows and the stock soars.

After Citron Research’s Andrew Left argued recently that GameStop would fall to $20 fast, he was widely mocked on the Reddit forum. People signed him up for Tinder and tried to guess his password on Twitter. Left said his family was also harassed. He withdrew from his short position and said he would no longer comment on the stock. “I had no idea what I’d set off,” he said in a video that felt not very different from a hostage scene. On Friday, Citron said it would no longer publish short-selling research after 20 years of doing so. “We will focus on giving long side multibagger opportunities for individual investors,” the firm said.

RIPPLE EFFECT

“I believe there is a systematic targeting of highly shorted stocks,” said Steve Sosnick, the chief strategist at Interactive Brokers, early in the week. He was quickly proved right.

AMC Entertainment Holdings (AMC), a movie-theater chain clinging to its life amid Covid-19 shutdowns and the rise of streaming, has seen its shares soar 278% amid interest from the retail crowd. Other out-of-favor stocks like BlackBerry (BB) and Bed Bath & Beyond (BBBY) surged amid last week’s frenzy.

The most-shorted stocks in the Russell 2000 have risen more than 80% since October, while the least-shorted ones are up less than 20%, according to Société Générale.

As heavily shorted stocks rose, hedge funds that bet against them flinched. The most notable of these was Melvin Capital, a hedge fund run by former SAC Capital portfolio manager Gabe Plotkin. As GameStop spiked, Melvin received $2.75 billion in emergency financing from Citadel and Point72. Melvin said that it had closed out of the GameStop position on Tuesday—a sign of victory for the Redditors. Wall Street’s biggest guns, like hedge fund and market maker Citadel, were in the middle of it, too, in part because of the firm’s market-making business with broker Robinhood and its investment in Melvin Capital.

The action in out-of-favor stocks spooked some hedge funds with sizable short bets. To close out those shorts amid soaring prices, some were forced to raise money by selling shares of well-liked stocks, notes Raymond James strategist Tavis McCourt. A basket of stocks popular among hedge funds saw significant drops during the week. Strategists said the action had quickly bled into even more sectors: The S&P 500 fell 3.3% this past week, its biggest drop since before the November presidential election.

“The next few weeks could be a wild ride,” wrote Oanda analyst Craig Erlam, and, given the market’s frothy valuations, it’s happening at “the worst possible time.”

LESSONS LEARNED

The sense from some on Wall Street was that all of this was wrong—if it didn’t rise to criminality, it at least overturned the order of things. But frankly, it’s not clear there is anything wrong with it. NYU’s Damodaran said he expected there to be continued cries of “ ‘we should regulate this, we should stop it.’ The reality is, I don’t think you can do it.”

The fact that a large number of investors had the same opinion about a stock and drove it to ridiculous levels isn’t illegal. If someone infused those discussions with misinformation, that might be different, and qualify as market manipulation, which is illegal. But finding manipulation in a boisterous online forum is a “needle in a haystack” problem, said Columbia Law School professor John Coffee.

“It is possible there are organized groups within WallStreetBets taking profits,” wrote Philip Moustakis, a lawyer at Seward & Kissel and a former Securities and Exchange Commission attorney, in an email. “It’s also possible this trading truly is as decentralized as it appears. And to the extent there is profit-taking, there is little indication that it is based on false information disseminated to the press, on Reddit, or elsewhere. This feels more like a collective mania: In the joy of gambling, in the joy of ‘owning’ the hedge funds who shorted the stocks.”

The SEC has said it is “monitoring” the situation, and members of Congress said there would be hearings. Those hearings could end up covering much more than why a stock rose. Rep. Alexandria Ocasio-Cortez (D., N.Y.), for instance, criticized Robinhood for blocking access to certain highflying stocks on Thursday. The company said it was forced to act quickly to blunt the impact of market activity, in part because of SEC capital requirements. Other brokers also changed their requirements for investing in the big movers.

“The commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities,” the SEC commissioners said in another statement on Friday.

William Galvin, the secretary of the Commonwealth of Massachusetts, said the New York Stock Exchange should halt trading in GameStop stock for 30 days so it can “cool down”—a suggestion that the NYSE didn’t comment on and didn’t appear to be contemplating.

Through the week, a political consensus seemed to be growing that the bad guys in this instance are the old Wall Street players, trying to blame the up-and-comers for making the market rattle. “Fully agree,” wrote Sen. Ted Cruz (R., Texas) on Twitter in response to Ocasio-Cortez, normally his fiercest opponent.

A Short Case for Stocks

Stocks with high short interest have made big moves this year. Here are the 15 stocks with the heaviest short interest.

Company / Ticker	Recent Price	Short Interest as % of Float	YTD Price Change
GameStop / GME	$325.00	121.1%	1,625%
fuboTV / FUBO	42.25	71.9	51
Ligand Pharmaceuticals / LGND	185.35	64.9	86
PubMatic / PUBM	39.75	63.3	42
Bed Bath & Beyond / BBBY	35.33	63.0	99
National Beverage / FIZZ	151.54	62.6	78
Alberton Acquisition / ALAC	12.83	62.1	12
AMC Networks / AMCX	49.42	57.9	38
SunPower / SPWR	54.01	57.5	111
Macerich / MAC	15.70	56.9	47
Tanger Factory Outlet Centers / SKT	15.43	52.4	55
Tootsie Roll Industries / TR	39.58	45.9	33
Accelerate Diagnostics / AXDX	10.26	44.9	35
Academy Sports and Outdoors / ASO	21.50	44.8	4
BigCommerce Holdings / BIGC	79.94	44.6	25

Note: Short interest as of Jan. 15

Sources: Dow Jones Market Data; Bloomberg

Other entities could face scrutiny, too. There was some evidence that it wasn’t just the little guys participating in the rally. “There’s absolutely institutional money at play here,” David Trainer, CEO of research firm New Constructs and a former analyst at Credit Suisse, told Barron’s. “If you look at the tape, there were 10,000-share blocks being traded,” he said.

If big players simply rode the wave, that would be OK. But if there’s evidence that they were involved in touting the stock, it could invite more scrutiny, Coffee said.

“ The thing is not to be short stocks with 150% short interest. As a risk manager, you have to look at all of these things. ”

— Jason Mudrick, founder of hedge fund Mudrick Capital Management

GameStop itself, which has stayed quiet during the run-up, may also face questions, former regulators said. It had announced in December it might sell stock at an “at-the-money” offering, and it could have taken advantage of the run-up to raise money. GameStop didn’t respond to requests for comment from Barron’s on whether it was doing so. Multiple board members declined to comment. AMC and Naked Brands Group (NAKD), whose stock also soared, raised cash during the frenzy.

WHAT’S NEXT

The fastest and biggest impact appears to be on short sellers. Losing an estimated $5 billion can change behavior, of course. Citron’s practice of announcing its short calls to much fanfare is over, and it’s unlikely that other funds will engage in it, either. In general, shorts will have to be both quieter and more careful.

“The thing is not to be short stocks with 150% short interest,” said Jason Mudrick, founder of hedge fund Mudrick Capital Management. “As a risk manager, you have to look at all of these things.”

Regulators will now probably try to impose new guardrails around retail trading. The SEC said last year that it was looking closer at options trading and how brokers disclose risks. Trading on margin could be curtailed, and the rules for getting into options may change.

Brokers will undoubtedly need to make changes, too. Their apps and websites have already been under pressure from a surge of retail trading. And several had to curb trading last week in some stocks for regulatory and financial reasons, angering customers. Ultimately, the brokers facilitated a frenzy they couldn’t keep up with. Now, they will have to adapt or watch their clients disappear. Robinhood, in particular, has much to prove, as the company is expected to go public this year.

Hedge funds—even those that don’t regularly go short—will also have to adjust. Much as they use alternative data to track credit card receipts and get ahead of earnings reports, they’ll now have to watch the message boards. Already, alt-data firms are ramping up their offerings, with web-crawling company Thinknum telling Barron’s that it just launched a product on Thursday specifically to track Reddit. “This new product tracks the number of times NYSE and Nasdaq tickers are mentioned in the top 100 posts on r/WallStreetBets and r/Stocks in real time,” the company said, referring to the popular Reddit forums. Already more than 50 hedge funds have asked about it.

The great innovation of 2021 is a robot that sifts through emojis for investment signals.

No, the retail revolution is clearly not going away, even if some market participants may hope it does. Those in on the fun should expect new margin limits with their brokers and possibly more stringent requirements for complex trading strategies. For everyone else, the message is more complicated. Buy-and-hold investors need to be aware of the trends, but they should stay away from the stocks.

Know this, too: The “crowd-squeeze,” as Damodaran calls the GameStop move, has already shown the potential to be a systemic risk to broader markets, particularly when pricey markets are looking for an excuse to correct.

Old-school investors are wary. Legendary bond investor Bill Gross called on Friday for government action to protect against the fallout of volatile trading. He also thinks that investors need to develop new models that rely “not just on the fundamentals of quarterly earnings reports” but also that “alert investors to improbable if not outlandish expectations.”

Reddit user benaffleks had a different take: “This is a big moment. A tug-of-war between tradition and the future. Hedge fund managers live in the past, and continue to look down upon the retail investors. They truly believe that we, the average retail investors, don’t know anything about finances or the market (which may be true), and we’re just gambling our money away.”

“This is the world they want to live in,” benaffleks added. “This was the past.”

Carleton English and Jacob Sonenshine contributed reporting to this article. 

Write to Avi Salzman at [e-mail] and Connor Smith at [e-mail]