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Heroic revenge on hedge funds for pyramid scams
The operation of the forums in Reddit caused billions of dollars in losses in the hedge funds in which the young investors wanted revenge.
But things did not end there and the result could be devastating
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Wall Street
Earth Age
Saturday, January 30, 2021, 7:30 p.m.
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Shook Wall Street, but could come back like a boomerang.
GameStop (Photo: GettyImages, Tayfun Coskan)
Gamestop stock, which has risen disproportionately in recent days, is making a lot of noise: the army of small investors in the Berdit forum has won hedge funds worth tens of billions.
What actually happened there?
The Melvin and Citron funds shorted a stock of a beloved gaming chain called GameStop, angering the Wallstreetbets forum.
Forum members aspired to take revenge on the hedge funds, which profited at the expense of GameStop, which was badly hit by the Corona as a physical game store, and decided to buy Gamestop shares at an exorbitant price.
They invited their friends to buy as well, the stock price went up, which brought more small investors into the business, and made the stock price go up even more.
Thus began an interesting phenomenon: those who were in a short position on GameStop discovered that they were about to lose a great deal of money.
Therefore, they rushed to close their position, i.e. buy the stock and return it to the lenders.
But this shopping spree created another increase in the stock's value, and at the time of writing (Thursday afternoon) its value had re-stabilized at about $ 300 per share, 1,600% more than its value a few months ago.
This phenomenon is called short squeezing, and it has resulted in huge losses to the hedge funds that the Wallstreetbets Forum wanted to avenge.
According to news sites, hedge funds have closed their short positions at billions of dollars in losses.
But things did not end there.
Forum members are now encouraging each other to buy more shares, and refuse to sell despite the potential profit (what they call "diamond hands").
They are led by a specific user run under the nickname Deepfuckingvalue, which aims to continue to encourage people to join the celebration and buy more shares.
In doing so, I fear, the heroic revenge on the hedge funds becomes a pyramid scam.
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The regulator has no reason to intervene
In pyramid scams create the illusion of a property worth more than it really is.
The one at the top of the pyramid encourages people to join in to raise the value even further, causing more and more people to come in later, hoping to earn even more.
But because the value inflates far beyond the real value of the real asset, the drop is inevitable.
If the one at the top of the pyramid leaves on time, he will make a fortune at the expense of those at the bottom of the pyramid, for example those who put on it the aid money they received as part of the corona crisis.
The regulator has no way to prevent such scams, because all actions are legitimate.
The only problematic thing done here is to spread propaganda about the expected increase in the value of a property, which is unlikely to come.
In contrast, the laws of the Wall Street-Bets Forum are supposed to prevent such a case, and they explicitly prohibit buying a stock in order to force people in a short position to exercise it at a loss, thus causing the stock to rise.
This, of course, is exactly what they did in the forum (which has since grown to more than 4.2 million users).
It seems that the forum moderators themselves are also deep inside, and do not stop the enthusiastic flow that encourages addiction to easy money.
Buy the yacht, lose the pants
Forum users, it seems, are selling themselves the illusion of a stock that will reach the moon, they say, and allow Deepfuckingvalue to "buy his yacht."
But even if he does win the yacht in question, many of those who came in late will find that they lost their pants as soon as the stock plummets back to its natural value.
Such phenomena have no regulatory solution, and the only way to defend against them is personal liability: do not enter into positions on specific stocks, which could cause you huge losses.
Relying on past experience, the only surefire way to make money from the capital market is to buy broad stocks of stocks, and invest in them for a long period of years.
The author is a regulatory researcher at the Ecclesiastical Forum and one of the founders of Freedom for All of Us, and financially advises the New Hope Party.
The above is not investment advice.
The writer would like to thank Yuval Ditsian for the insights.
What is a short?
A short is a financial move in the capital market designed to profit from a decline in the value of a stock.
Entry into a short position is done as follows: Borrow a stock for a specified time from someone who holds it, and sell it immediately.
Towards the expiration date of the loan, the share is repurchased in the capital market, and returned to the lender.
In this way, you can earn the negative difference between the prices - the lower the stock, the higher the profit of the shortlist.
The risk is that the profit ceiling is limited (at the level of the share value at the beginning of the short), but the loss ceiling is unlimited (depending on the value at the end of the short).
The hedge funds that invested in GameStop experienced firsthand this full risk.
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