During January 2021, the stock price of video game retailer GameStop rose at an unprecedented pace. GameStop stock closed at just $17.25 per share at the beginning of January and proceeded to shoot up to more than $347 per share by January 27th. While this may seem like a normal market movement at first glance, many investors believed GameStop’s stock price did not actually reflect the true value of the company. Their concerns proved to be well-founded, as a closer look revealed a “pump and dump” scheme conducted by members of a popular message board on Reddit who were targeting hedge funds for taking short positions. While investors who got in early on the scheme were able to realize significant profits, late-comers were left holding the bag, and the hedge funds who had taken a short position on GameStop, and others lost an estimated $70 billion according to Ortex data.
Investors who were not familiar with GameStop or Reddit may not have realized the significance of this incident, but it tells us a lot about stock market investing and whether it is safe for people in or near retirement. If you are wondering how the GameStop incident relates to your retirement investments, keep reading.
What is Short Selling?
You may remember hearing about stocks being shorted during the 2008 financial crisis, and it is also at the core of the GameStop incident. When an investor or hedge fund sells short, it means that they are making a bet that the price of a security will go down. If the price goes down, the short seller makes a profit; if the price of the stock goes up, the investor or hedge fund loses money on their investment.
As online shopping has become more popular, brick-and-mortar retailers like GameStop have seen the volume of their business decrease, and the price of their stocks fall. Hedge funds picked up on this trend and began taking a short position on these companies. GameStop was heavily shorted, with 140% of their public shares being shorted on January 22nd, 2021. While some may debate the ethics of shorting stocks, it is a legal and normal part of the way Wall Street conducts business. If Reddit investors had not targeted hedge funds who were shorting stocks like GameStop, those hedge funds would have made billions.
Reddit and Robinhood
As GameStop and a handful of other companies became heavily shorted, some “retail” investors saw potential to upset the established order. They gathered in an online community on Reddit known as “WallStreetBets” where they discussed a plan to buy up heavily shorted stocks like GameStop, Blackberry, and AMC Theaters, which became known as “meme stocks.” As more and more investors jumped on board, the price of these stocks rose rapidly, surpassing even the most optimistic expectations. This sharp rise attracted attention from the media and from public figures like Elon Musk, whose January 26th tweet about GameStop corresponded with a spike in the company’s stock price. While this was good news for investors who purchased GameStop stock, hedge funds who had shorted the company realized they were poised to lose billions.
Many of GameStop’s new investors were young people who had never owned stock before and were using mobile apps like Robinhood to make their trades. In response to the increased trading volume on their platforms, Charles Schwab, TD Ameritrade, and Robinhood all placed purchase limits on the “meme stocks”, preventing small-scale retail investors from buying any more shares. At the same time however, they allowed institutional investors on Wall Street to close out their short positions before they lost too much money. Many involved saw this as an unfair advantage that would not be extended to small-scale investors who lost money on these trading platforms, or had their accounts cashed out and closed without their authorization.
Thanks in part to Robinhood’s trading restrictions, GameStop’s stock price plunged at the beginning of February, closing below $100 dollars by February 2nd. Investors who closed out their positions early made millions, while those who were late to the game lost significant portions of their investments. Because they could close out their short positions before the crash, many of the hedge funds involved were able to minimize their losses. Executives at companies like GameStop, Blackberry, and AMC also made millions selling stock in their own companies before the crash, prompting accusations of insider trading. Some have also accused Robinhood and Reddit of market manipulation, an accusation that is currently under investigation by the Securities and Exchange Commission (SEC) as well as the United States Congress. Although, this would not be the first time that the trading app Robinhood was scrutinized for not putting the best interest of their consumers first.
The CEO of Robinhood, as well as executives from Reddit, Melvin Capital, and Citadel were brought before Congress to testify about the incident on February 18th. Robinhood CEO Vlad Tenev denied that he colluded with hedge funds to lower the price of GameStop when the trading app was limiting GameStop trades. Although a second hearing has been scheduled, it looks like none of those involved will face any immediate consequences for their actions. Furthermore, while Congress and the SEC continue to investigate the situation, it seems unlikely that any significant changes will occur on Wall Street in the foreseeable future.
What Does the GameStop Incident Mean for Your Retirement?
A story this complex and convoluted seems like something Hollywood might dream up. So how does it relate to your retirement savings? In short, the GameStop incident is strong evidence that investing in the stock market or any securities-based investment is a tremendous risk for anyone in or near retirement. While the young investors and hedge funds who lost money during this saga have the time and resources to recoup their losses, seniors preparing for, or living in retirement do not. The restrictions placed on retail investors by Robinhood and other trading platforms also show that the stock market is not as free or as fair as you might think. While small-scale investors lost millions, hedge funds were afforded the opportunity to mitigate their losses, and executives who made profitable trades based on information gathered on Reddit are unlikely to face any criminal charges. It is not entirely clear who the winners and losers were in this scenario, but one thing is certain: the stock market can be easily manipulated, making investing in the stock market a risky proposition, especially for people approaching retirement age.