For those who don’t fall what’s happening on Wall Street, the last few weeks have shown a new type of market disruption — i.e. what can happen when a large group of small investors use an internet forum, such as Reddit, to coalesce and stick it to a group of hedge funds those buyers hold responsible for their problems with the financial industry.
The now-infamous GameStop stock short recently was a perfect example of this new dynamic.
“When hedge funds or individuals ‘short’ stocks, what they’re basically doing is borrowing stocks that they don’t own and selling them to other people,” said Bradley Hartman, the owner of Hartman Financial Planning and hartmanfinancialplanning.com.
“And so what happened was some hedge funds had shorted a bunch of stocks of companies they thought would probably go bankrupt over the long term, such as GameStop, AMC, Best Buy,” he added, “and there were bound to be a few of them.”
The results were pretty instantaneous, for a market that traditionally known for responding to what’s expected to happen six months from today: Almost overnight, Robinhood, one of many investment apps that have increased buyer access to the stock market, gained national notoriety for responding to the GameStop stock sales by freezing the ability to trade the stockin response to massive movement meant to drive up the price.
The holds by Robinhood helped the hedge funds’ shore up their positions and potentially cost the app’s users millions — and created whole new set of questions for the marketplace in the process.
Essentially, once a Reddit community, named WallStreetBets, found out about these hedge fund shorts and realized that these hedge funds were betting against these companies, these internet investors with only a few hundred or a few thousand dollars to spend, decided to collectively work together to both make money and get their revenge on Wall Street.
“There was a lot of untapped anger directed at the hedge firms for what happened in 2008 with the economic crisis and it felt like no one got punished for it,” said Jared O’Brien, a member of /r/WallStreetBets who jumped into the stock market as a hobbyist at the beginning of the pandemic. “So everyone wanted to jump on them, but when you jump in the ocean with sharks — it’s not going to end up well.”
Working together, the Reddit.com community began snatching up thousands upon thousands of Gamestop stocks, among these other companies, spending their life savings and largely catalyzed toward purchasing the brick-and-mortar gaming company’s stock due to an individual on a Reddit forum.
Gamestop’s stock for instance had been, in the last year, at a low of $2.57 a share. But by the peak of the bull rush had reached $483 per share over the course of a few weeks.
The danger in ‘diamond hands’
A term regularly floating around in these spheres online is the term “diamond hands,” which became popular recently on Reddit as the price of (Gamestop) GME stock plummeted back down to double-digits.
“‘Diamond hands’ means that even when it’s going down that there are at least some people that are not going to sell, they might even buy more,” said O’Brien. “And just again, some of these people are still angry at what the hedge firms have done.”
A number of the Reddit day traders still posted this week about holding their stocks, with some of these people who spent $400-$500 on their original investments showing millions of dollars in gains and losses over the course of the last few weeks.
“I think this is going to be an issue going forward,” said O’Brien, who said he himself has earned a few thousand dollars over the course of the last year before he sold off his position. “There were some serious players on there, some legendary stories, of guys losing hundreds of thousands, a couple guys losing millions of dollars. They post those losses almost as a badge of honor.
“I think after another week or so, is when the real problems are starting and there probably will be a higher chance of pump and dumps, I think,” he added, referring to the practice of buying a stock for a few weeks and then getting rid of it as soon as a quick profit it available or as soon as things don’t work out as planned.
Hartman said he still has confidence in the stock market moving forward, despite possible future ploys like this.
“I think people can have confidence in the stock market moving forward, because I think it means that playing in those particular waters shows that it’s dangerous,” said Hartman. “And you will see some of the things about somebody that took their $1000 stimulus check and turned it into $40,000 to pay off their student debt. But basically, Gamestop dropped 60% in value today, so whoever was part of that group of people that got Gamestop in the last day or two just lost 60% of their investment.”
Think in the long term
“The stock market is for the long term, and in that picture you have to know that volatility is a part of the game,” said Patti Handy, a wealth adviser with Vance Wealth based in Santa Clarita. “I think Warren Buffet has a quote that says, “Our favorite (holding) time is forever.”
Handy said that those who jump out of the market after some volatility related to their more certain positions to jump in other games, can sometimes end up regretting that decision.
“The stock market is not a place to invest if you’re looking at needing your cash short term, and by that I mean, you know, anything from three to five years,” said Handy. “If you need your money to buy a house, or to put your kids through college or what not, you really should not be in the stock market.”
“The stock market is a long-term investment, it’s a buy and hold, and that’s the strategy we work with,” said Handy. “And again, looking at the client’s risk tolerance, time horizon, and whatever else is happening in their personal life and their needs, given their individual situation.”