Well … that was quick. In two weeks, GameStop (NYSE:GME) and AMC (NYSE:AMC) stock investors went from being new creators of Wall Street kings to naive newbies. As the shares fed by Reddit fell back to the ground, young Reddit investors watched in dismay as their heat-seeking investments turned to dust. And before even more experienced investors could start their “I warned” lectures, one thing was clear: less experienced investors have already started to draw the wrong lessons from the fiasco.
Source: Shutterstock / TY Lim
Yes, hedge funds with lots of money won at the expense of the retail investor – Citadel and Point72 will likely come out with a $ 2 billion gain this week. But as new investors feed their meme stock losses, there is a great temptation to blame themselves or “the system” wrongly. But if that’s not why they lost, what was it?
GME and AMC stock: the system is assembled!
It’s easy to think of Reddit investors as a single person – last month, r / WallStreetBets seemed to have a life of its own. But for every smart (or lucky) soul who bought GameStop for less than $ 10, many more on the popular forum talked about being late. These were the investors who paid $ 100 or more per share – encouraged by other Redditors with expired cash options. (Some of these early risers ended up being financial professionals working on Reddit.)
In other words, what started out as justified anger at short-sellers turned into a bomb and eviction from people who knew what they were doing. So, in the end, it was the novice investor who lost the war.
But who is to blame?
Wall Street mostly watched from the outside, letting novice investors make mistakes. The big banks vigorously guard their stock research reports, handing them over only to multimillionaires and family offices (that is, the same people who can ignore the advice). And the educational system in the United States has not been much better. With their focus on efficient markets and financial theory, most schools do not prepare people for the possibility of losing 30% of their savings in a recession.
That’s why young investors have filled the vacuum for themselves, using social networks like Reddit to share stories and advice. And it is not surprising that the echo chamber has created a whole generation of investors far more emotional than their predecessors.
These investors are “characterized as having the highest rating for loss personalization, although they still have high risk ratings,” explains researchers Ryan Wood and Judith Lynne Zaichkowsky in Journal of Behavioral Finance. “In other words, this group doesn’t mind taking risks, but they feel terrible when they lose money.”
But, really, the system seems manipulated
In some cases, Reddit’s echo chamber got things right. When Robinhood prevented retail investors from trading on highly volatile stocks on January 25, the trading platform may have unwittingly burst the GameStop bubble, providing a lifesaver for hedge funds with short positions. Robinhood CEO Vlad Tenev must expect tough treatment when he is questioned by Congress later this month.
But in other cases, the Reddit rumor has become a scourge.
“I still have my shares, but I don’t expect to see my ~ $ 1200 again,” lamented a GameStop investor on Reddit. “Who knows … Maybe I still go to the moon. I would be thrilled! But until then, I’ll wait, ”said another latecomer at AMC.
As meme stocks fell from their heights, Redditors were encouraged to adopt the “ostrich strategy”: ignore losses long enough and perhaps they will disappear.
Much of that feeling was fueled by others doing the same – and in some cases posting duplicate images. (If all these images are 100% real, this is a matter of debate). But the rest comes from the younger investors’ natural tendency to embody losses. If losing money makes you stupid, then just never notice those losses. It is an old strategy of short-term self-care with long-term costs.
Older investors can see this mental gymnastics with a sense of schadenfreude; all experienced investors have seen their share of battle scars. But this time is different. With Reddit’s echo chamber expanding these practices, these investors are at risk of blaming everyone (including themselves) for their losses and not moving on.
Wall Street also learns the wrong lessons
The Reddit machine also has real-world consequences for experienced investors. Consider Andrew Left, CEO of Citron Research. For years, Mr. Left criticized the excesses of Wall Street, controlling corporate giants like Valeant to corner drug markets and raise prices. His willingness to go against the establishment of Wall Street has earned him praise from academics and seasoned investors.
But then, he made the mistake of announcing GameStop’s absurd assessment at the time that Reddit investors were entering. As death threats and random orders of pizza appeared at Mr. Left’s door, the respected short seller vowed never to publish short sales research again.
The inhibiting effect of Reddit has since spread to other areas of finance. Talks about short selling, an essential mechanism for a well-functioning financial market, almost stopped. And investors can probably expect higher premiums the next time they look to trade any stock with meme potential.
Where to go from here
Never have so many investors personified stocks as their identity. For these investors, telling them you don’t like Tesla’s stock is almost like spitting in their face. (Older investors, for their part, may see Tesla as more of a chit). And the GameStop bubble is cementing the myth that someone’s stock portfolio represents their own character.
Against this background, we are now faced with a decision. We can choose to say nothing; few want to speak out against the madness of the crowds, especially when they can shout at you.
Or we can continue to reach out and try to help the next generation make sense of the world we have built.
After all, Gen Y investors won’t be leaving anytime soon. In 2030, young investors will have inherited $ 68 trillion, making them one of the most significant financial forces of our time. And if we forget to give them the instruction manual, what does that say about us?
As of the date of publication, Tom Yeung had (directly or indirectly) no positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment consultant with a mission to bring simplicity to the investment world.