The Impact of Social Trading on the Future of Stock Markets
The year 2021 started of with global headlines mainly focused on the healthcare sector as a result of the COVID-19 pandemic. Whilst healthcare delivery was still being prioritized, the world suddenly witnessed a never-seen before event on the stock market that made a shocking impact on Wall Street and took the internet by storm.
GameStop Corp, trading on the New York Stock Exchange as GME is an American retail gaming and consumer electronics merchandiser, whilst Reddit is a popular online hang out social media platform. An internet group of traders rallied together on Reddit to short-squeeze the value of GameStop’s stock literally overnight and the precedent has created a new perspective over the way markets work.
In this episode of the Business Transformation Explained webinar series, CEO of EROE and Co-Founder at EroeGo Daniel Solomon together with his expert line up of Speakers; Richie Santosdiaz and Mehdi El Amine Fichtali share their thoughts by helping to put an economic value on the conversation.
Richie is an economic development expert providing diversification advisory services to governments and multinational organisations. He is currently the Head of Middle East and Africa (MEA) for the FinTech Times and the FinTech Power 50. He describes the FinTech Times as the ‘oldest’ newspaper in the world dedicated exclusively to FinTech. With its headquarters in the UK, it was founded in 2016 and is steadily growing its audience in the MEA region.
Mehdi El Amine Fichtali
Mehdi is the Founder of FinaMaze, an ADGM-based AI robo asset management firm based in Abu Dhabi. Established in 2018, the FinaMaze platform helps investors especially retail investors in the market with tailor made portfolios they can align themselves to. Prior to that, he started working in financial markets since the early 2000’s mainly on the trading floors and international banks in Paris, London and then Dubai where he has lived since 2005.
Decoding the Saga – what really happened with the Reddit Platform and GameStop Corp?
There have been many stories of how the stock market started from the story of Mrs. Watanabe, a Japanese housewife who started currency trading; from the Yen to the US and Australian dollar.
Understanding what happened will also take us down memory lane to the 1980’s when the equality gap in pay between for example C-suite and entry level workers were reasonable. Fast forward to the 2000’s, the situation has changed with the gap widening. This led to a situation where the rich were getting richer, with the poor getting poorer; leading to a general but silent rebellion and anger. There has also been a decline of brick-and-mortar retail, and a rise in digital experience; a trend that has grown globally especially in America and Western Europe and this has affected hedge funds.
GameStop is very popular among people mostly in their thirties to forties because most of them bought videos games from the store whilst they were young. This according to Mehdi has makes them have an emotional attachment to the brand.” Some of these people have even moved on to Wall Street. In the finance world there are still movers who advice hedge funds on which companies have a future and which ones don’t. With companies like Amazon becoming a competitor to GameStop as a result of digitization, buying shares from the latter wasn’t an option.
However, in January 2021 GameStop announced that it had added three new directors to the board leading to a slight rise in the price of its stocks. Paper trails and conversation tracking showed that internet traders on the Reddit platform also came together to buy shares to ‘save’ the Company they have always been emotionally attached to. When you first buy shares, the price is formed between the ratio of demand and supply. And so, the more the supply, the more were there people who were watching and pushing the price of GameStop’s stock price higher and higher. This led to the hedge funds being short-squeezed in a way that they were forced to buy back the shares at a higher price. The high price was pushed by Reddit payers.
Why does it always appear that hedge funds are always investing in companies that are likely to go extinct?
What Mehdi thinks can be as a result of it being common knowledge that some hedge funds have sold their securities and need to buy it back. What happened with GameStop is that the Reddit faction knew about these hedge funds; that they were enterprises with moving capital, and so they would rather ‘bet’ with a company they were emotionally attached to. They were interested in saving the company regardless of the price of shares and without knowing its economic fundamentals.
Short-squeeze in the GameStop story
When people invest in shares, they do so with the aim of making profits. And so, when these hedge funds give out shares at a low price and it has to be sold back to them at a much higher price, they do not have any options than to pay. Traders also take advantage of this when they anticipate a fall in prices. This is how stock selling works sometimes and it played out in the GameStop and Reddit saga.
A situation as this can lead to the rich getting richer, and the poor getting poorer which was clearly evident in the 2008 financial crisis globally. People have lost a chunk of their portfolios due to being short-squeezed. “What’s interesting is that we all know the retail market in America is going bad, so how can a company like GameStop all of a sudden have their shares go up and soar through the roof”, Richie asks?
Connecting demand with supply – the stock market and social media
In figuring out this, Richie thinks that it is the coming together of bored and angry people. For instance, for the bored sports also stopped for a while and so did betting. This led to most of these people migrating into stock trading because they had nothing else to do. For the angry, times are not easy right now from an economic point of view, GDP in the G20 area for example fell by (minus) 9.1 % in the second quarter of 2020, people have lost their jobs and most had the same issue in the 2008 recession; either under employed or unemployed.
In Mehdi’s view, manipulating prices is illegal and unlawful. However, there was the right combination of factors because of emotions and also means of paying. Remember, this happened like nine months into COVID where most of the rich Americans were working from home, getting bored, got subsidies from the government, were not spending on restaurant and travel bills for example, so a lot of their fund money was channeled into the stock market. The situation was conducive with platforms like Robinhood to aid trading. It was a small stock market so any purchase could translate into the rise in price. There were more passive investors who also followed the index and bought whatever was there. It was a clear case of the surge of volatility exasperated by social trading.
Robinhood CEO talked to Elon Musk and they had to put 3 billion on the table for the volatile stock market. How was Robinhood trying to help people make money and at the same time trying to put a stop to it?
The answer is simple. When you buy a stock, you do not become owner of the stock instantly but you have to wait for the clearing house to transfer the shares to you which happens fourty-eight hours later. The broker in this case Robinhood had enough money sitting at the clearing house with all the capital. The defense of Robinhood is that they didn’t stop the purchasing of GameStop’s shares because they had the privilege of the big hedge fund industry. Then at a point they only allowed them to sell and this pushed the prices and so they were forced to take losses. They needed risk capital and so they themselves were in a short-squeeze position.
The ethical interference in the GameStop saga in relation to Robinhood
There should be regulatory framework to guard against volatile markets through companies that are trading way beyond their economic value. This is where FinTech comes in. FinTech industry globally is valued at over 100 billion dollars. We can’t blame Robinhood much because FinTech is an innovative technology. The interesting thing is that during the 2008 financial crisis FinTech grew and that is when we saw for example the rise of RegTech. FinTech is now being used as a way to be compliant and so has solidified its standing as the solution moving forward especially now that everything is going virtual and digital.
How do we ensure that the small investors and social traders also know that they have a role to play in the market?
There has to be a proper mix of having have a free market and a benchmark where you have a strong inventory. There must also be education of investors. Companies and hedge funds put lines to their trading because they know that as humans our emotions play out the balance between fear and greed. Fear of losing money or greed of making more and because of this people should not trade based on emotions. Allow yourself to make money because of timing and if the timing is right, you will make money.
In this digital age, if Artificial Intelligence is programmed well and coded by people who are objective, it can also give us some answers on how to take out the emotions. Emotions are not bad; they just need to be controlled.
Social trading going forward
Compliance and FinTech will continue to play its role. There should be bigger responsibilities for hedge funds with regulators having more focus on them. The idea is not to give all the power back to the regulator or to compliance, and they shouldn’t be encouraged to stop Fintech innovations. Responsibility has to be given to big banks and hedge funds who can put in limits to help minimize the impact of emotions.
The trading fancy is still there and social media isn’t going to go away but rather get bigger, if we are to take Reddit for example. In all this, the trading ecosystem has remained positive despite somewhat negative press and this is a good thing.
Investments require people to read a lot, be disciplined, wise, and emotionally intelligent of greed and fear. Therefore, it is unrealistic to invest in a minimum time and expect to reap suddenly with luck on your side. It is important to understand the reason why you are buying securities by taking an informed view. There are also professionals who help manage risks that you can reach out to.
People want to benefit from the market and make some money one way or another especially in these times of lockdowns. Can there be a 2.0 version of what happened with GameStop and Reddit? Yes. However, at the end of the day everyone should invest what they can risk, and not bet on what they can’t lose. Invest not because prices are going high but because of the economic fundamentals attached to it.