8 Ways Reddit Will Change Trading

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GameStop’s surprise rally will have implications for every investor

From the drudgery of increasing irrelevance sparked what has got to be Wall Street’s unlikeliest rally. On the final session of January, brick-and-mortar video game retailer GameStop (NYSE:GME) closed at a remarkable price of $325. On a year-to-date basis, shares are up 1,784%, blowing apart the most fantastical stock predictions for 2021. And what is the catalyst for all this? Reddit, of course!

It’s a fascinating tale sure to make for a Hollywood expose ala “The Big Short.” According to the Wall Street Journal, Keith Gill, a Reddit user with an influential social media profile spearheaded GameStop mania. Essentially, Gill and his followers aimed to induce a short squeeze – a phenomenon where rising prices cause bearish traders to cover their positions at inflated valuations, driving up the target asset even more.

Frankly, it’s an ingenious move, although one fraught with risk. Yes, a short squeeze is the ever-present danger of opening a directly bearish position on a security. However, getting the pull to convince other retail investors to move against major hedge funds initiating said short positions is also treacherous. Yet for the first time, such wrangling in the market has more than a profit motive; indeed, this is about revenge against the leaching fat cats.

And that’s what makes stock predictions in this Reddit ecosystem even more convoluted. Tapping into the desire to make money is one thing. But to add a layer of a higher purpose and impose justice on the billionaires that profited during the novel coronavirus pandemic while everyone else suffered? That’s a position even a priest would be hard-pressed not to take.

However, those who are making extremely bullish stock predictions off this dynamic should be careful. As Thomas Gorman, partner at international law firm Dorsey Whitney stated, “…there should be no doubt that the SEC is watching carefully…looking for anything that crosses the legal lines they are charged with monitoring.” Thus, regulatory oversight into coordinated manipulation across social media is one way Reddit may have changed the game. Here are eight other disruptions to watch moving forward.

  • Strong interest in stocks
  • New analytical methods
  • Empowering the masses
  • Political consensus
  • A shorting rethink
  • Getting a bad rep
  • Hall pass for flunkies
  • Unintended consequences

As crazy as this Reddit saga has been, you want to be careful. Take it from me. Back in June of last year, I suggested that GME offered a contrarian opportunity based on the cheap entertainment thesis. I expected maybe a two or three-banger, not one of the greatest stock predictions of all time. Honestly, it was dumb luck. Nevertheless, these are the ways Reddit may fundamentally alter Wall Street.

Thanks to Reddit, Interest in Stocks Will Boon

On a positive note, the Reddit army couldn’t have delivered better advertising for Wall Street than through its public destruction of a few short-selling hedge funds. Yes, on the surface, the folks at the r/WallStreetBets forum are modern-day Robinhoods – the mythical character, not the trading app – giving the fat cats a taste of their own medicine.

But the ironic dilemma is that because this battle between the bulls and bears is occurring in the stock market, that’s where the attention naturally focuses. It’s not as if the retail folks and the hedge funds were duking it out in the cryptocurrency arena. Therefore, while the suits are publicly putting on a sad face, deep down, the real elites are probably happy about the Reddit revolution.

Indulge my (hopefully well-reasoned) conspiracy theory for a second. Late last week, Robinhood the app took the extraordinary measure of shutting down buy orders for GME. Rival brokerages imposed similar restrictions on GME and other Reddit-driven trades. Unsurprisingly, this only incensed the so-called 99%.

And where are these angry people going? Wall Street, where else?

Forging a New Analytical Methodology

One of the immediate consequences of the Reddit saga is that it turned the art of stock predictions on its head. Of course, the concept of forecasting will never go away. But with the equities sector, analysts largely depend on two methodologies: the most common fundamental approach and the technical approach.

Now, we can add another one to the mix: analyzing a company’s short percentage of float and gambling on the most “hated” names.

Over time, you would expect such a ridiculous methodology to fade away. But in the meantime, this new approach – well, it isn’t “new” per say but it’s taken on unprecedented importance – will dominate the airwaves. Further, because so many retail investors are buying GME, other investments have shed interest.

Again, this throws stock predictions via standard methodologies for a loop. As a side effect, it also adds to the mystique of the Reddit army and its newfound role as a Wall Street influencer.

Empowerment for All

As you probably know, Reddit can be a nasty place. It’s amazing the kind of courage anonymity extracts. However, not everything about this drama involves belittling others or other unpleasantries.

In fact, I came across a story of a 10-year-old boy from San Antonio who cashed out on GameStop shares he received as a gift more than a year ago. According to a Fox Business article, Jaydyn Carr hauled in a profit of just under $3,200.

That’s lesson number one: there’s no shame in taking profits.

The other? Jaydyn’s mother Nina stated that $2,200 will go toward her son’s savings account while the other $1,000 will be allocated toward new investment opportunities. In other words, the mother-son duo is saving what they can and reinvesting the remaining funds. I believe Jaydyn has a bright future ahead with such a great financial foundation.

Naturally, these feel-good stories get swept away from the salacious or controversial headlines. That’s a shame because what the Reddit drama demonstrated was that every once in a while, the little guy gets their moment of empowerment.

A Rare Political Consensus

After a tumultuous election cycle last year that catapulted even more chaos, I think I speak for all Americans in that we’re ready to just move forward. Yes, we can be vindictive, but what’s the point? The world doesn’t stop turning because of our bitterness toward the democratic process.

Unfortunately, that didn’t stop the Washington machinery from digging up more trouble and nonsense. It appeared that we were again on the verge of vitriolic clashes in government. Then, something unexpected happened. Because of the Reddit-fueled drama, we witnessed rare consensus between Democrats and Republicans.

When Congresswoman Alexandria Ocasio-Cortez, better known as AOC, criticized Robinhood for preventing retail investors from doing what billionaire hedge fund owners do all the time, Senator Ted Cruz tweeted his support. To be fair, AOC later responded that Cruz almost got her killed during “the incident.”

But let’s not ruin the moment. When regular folks’ money is involved, suddenly, both parties see potential votes. Thus, legislation for a fairer and more transparent system could be one of the longer-lasting changes that Reddit has imparted.

Hedge Funds to Rethink Shorting

On the not-so-pleasant side of the spectrum (at least for the short-selling hedge funds), many will rethink shorting stocks. I’m not just talking about companies specializing in the bearish trade but rather retail investors who also play the same game. Simply, it’s become too dangerous in this emotionally heightened environment.

In fact, Reddit has already won a major battle. Last Friday, Andrew Left, the notorious bearish trader who founded Citron Research, declared that his company will no longer publish short-selling research. That’s a profound paradigm shift as Citron has almost become synonymous with the short sale.

While I can’t be for certain, my gut tells me that Citron won’t be the only one making this pivot. Short-selling a stock is inherently dangerous because theoretically, there’s no limit to how high it can go. Thus, liabilities can get out of control, especially if bullish fervor exists.

Short Sellers Get a Bad Name

Elon Musk of Tesla (NASDAQ:TSLA) is many things, but a fan of short sellers he is not. Since as long as I can remember, Musk has railed against the practice. Recently, he tweeted that “shorting is a scam legal only for vestigial reasons.” As well, Musk supports making short selling illegal.

Prior to the GameStop rally, many people shrugged off these complaints as part of the Tesla CEO’s unique eccentricities. However, his words now carry substantial weight which may have unintended consequences. You see, there’s a little bit of hypocrisy involved in this feud between bulls and bears.

Yes, short selling is speculation but so is long-sided trading! I think we delude ourselves that just because a vanilla long position doesn’t pose unlimited risk that somehow, it’s significantly safer than short selling. If you lose it all, it doesn’t matter which way you lost it.

Plus, who else is going to take the other side of the bet? Eventually, you must have the short sellers in the picture, just like you need two teams to compete in the Super Bowl.

Undeserving Companies Get a Pass

The above segues into another point about short sellers: they serve valuable functions in the market.

Primarily, short sellers inject liquidity into the market. Indeed, before Reddit and GameStop, the Wall Street Journal ran a story urging policymakers to abandon the proposal to ban short selling. The op-ed stated:

History has shown that short-selling restrictions don’t dampen downward price movements and volatility. They exacerbate them. Short-sale bans are ineffective and counterproductive. They reduce liquidity and introduce confusion at a time when the smooth functioning of markets is critical. They don’t support stock prices; they prevent accurate price discovery.

Another point: short sellers expose failing companies and especially those involved in fraud. As a matter of fact, short-selling expert James Chanos brought a spotlight to Enron, noting several fiscal red flags.

In other words, short sellers are the market’s equivalent of defensive backs. Their job is to strike fear in the hearts of wide receivers; otherwise, they’ll run all kinds of passing routes with impunity. Frankly, some companies legitimately need to get knocked “TFO,” as the kids like to say. Banning short sellers will impede the market’s self-correcting mechanism.

Wealth Transfer Between Jerks

Perhaps the greatest change that the Reddit army sparked is that it hardly changed anything at all. Yes, many anonymous Redditers were able to secure funds for noble causes, such as helping their family out of a bind or paying for medical bills. But in the big picture, the GME story is a wealth transfer from one set of jerks to another.

Now, I’m probably going to get a lot of heat for saying this. But it’s amazing to me that while we typically view people gambling their life savings at a Las Vegas casino as degenerates, when we change the scenery to an online brokerage, they’re HODL-ing heroes.

Here’s another acronym for you: WTF?

I mean, isn’t the underlying message that if you pick the right stock or scratch the right lottery ticket, your problems go away? Don’t get me wrong – I have no love for the hedge funds. But I also think it’s a jerk move to whip less-experienced investors into a frenzy to HODL to infinity or whatever hyperbole is out there.

Folks, GME is speculation and should be treated as such.

Let’s Get Real

As a “bonus” pointer, I want to talk to you about something serious. When this bubble bursts – because it invariably will – many people will get hurt. We’re talking households that were already on their last dollar who saw GME as a lottery ticket out of their misery.

When the lights go out, so will theirs. Later, you’ll find out that your noble flagship HODL-ers have already moved onto their next target, whipping a new wave of inexperienced investors into a frenzy. And the cycle continues. When the music stops and reality sinks in, it will be too much of a bitter pill for some to swallow.

As well, I fear that we’re witnessing a severe gambling addiction taking over this country. Combined with the destruction of the pandemic, I’m not overly optimistic about future stability.

If you’re struggling with whatever issue, I urge you to seek help. Government-run SAMHSA provides multiple resources and is available 24/7/365.

Investing should be fun and rewarding. But this is turning into something entirely different. Please be careful.

On the date of publication, Josh Enomoto held a long position in GME.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.

Note: This article originally appeared at InvestorPlace.