Online Traders vs Hedge Funds

The recent GameStop frenzy raises questions about the implications of individual investors and personal stock trading apps in our market-driven economy.


What happened?


Two weeks ago, amateur traders coordinated themselves on Reddit, a social media platform, to send the share price of certain companies sky-rocketing. They used personal investment apps such as Robinhood to buy and sell the shares. This was a blow to established hedge funds that had bet against these companies. The main companies concerned were, amongst others, GameStop, a video game retailer, Bath & Body works, a beauty products brand, AMC, a cinema chain, and BlackBerry, a phone maker .


Large hedge funds, such as Melvin Capital which lost 53% in January, were short-selling these companies’ shares. This means that they would have profited from the fall in their share price. Reddit investors squeezed the price of shares up, thus forcing hedge funds to buy stocks in order to limit their loss, a behaviour that pushed the price up even further.


Why is this important?


These were quite extraordinary events because ordinary investors induced large funds to accumulate significant losses. This strategy fits the image that many personal investment apps want to market themselves with. The main app used in the process was Robinhood which claims to be a tool to democratise finance and spread the opportunities of trading to everyone.


Such apps, and some of the behaviours associated with them, pose several issues. First of all, although they benefit those with an understanding of the financial sector, they encourage risk-taking from people who do not understand what they are doing. This is especially true with “zero-commission” apps such as Robinhood because they allow people to gamble their initial investment many times. There has also been an associated rise of “financial influencers” on social media like Tik Tok who give advice that may lead to disasters. Moreover, it is unclear whether these influencers profit from the advice they give. Such freedom with money can be dangerous. A 20 year-old trader killed himself last year thinking he had made big losses on Robinhood. The family is now suing the app for allowing him to take on the risk. Some people, bored from being locked-up and unable to go to casinos or to bet on sports, actually took up trading instead.


Secondly, the independence of these personal investment apps is not clear. Robinhood is currently valued at $20 billion and has 13 million users. The company, offering a free service, makes money from directing its users towards those who are most likely to be interested in buying and selling shares, meaning mainly established Wall Street funds. These funds pay Robinhood for the traffic it directs to them. In December 2020, Robinhood had to pay a $65 million settlement fine for reselling its clients’ investments to the hedge fund Citadel and for its failure to disclose payment practices. Finally, on January 28, Robinhood blocked its users from buying GameStop and AMC shares after their price shot-up and increased volatility. A class-action for alleged market manipulation was launched by a customer against Robinhood on the same day. All of this demonstrates that Robinhood’s goal of democratising trading is primarily a marketing strategy.


What do these events teach us?


The main take-away is that the pandemic and the associated boom in technology have made markets even more unstable than before. The rise of share-holder capitalism means that investing is one of the most profitable ways to make a living but it has also made the economy more focused on inflation than on employment or growth. The problems that such an approach poses have been exposed by the GameStop events. They have demonstrated to us how dependent we are on markets and how volatile these are.


The increased access to information has come hand in hand with an increased amount of individual responsibility. For instance, people now often have to take decisions on their pension plans themselves rather than these decisions being taken at company level. Robinhood’s democratisation goals actually put responsibility on people for not only their own ill-informed decisions but also the unpredictable fluctuations of markets. Giving people the opportunity to speculate alongside Wall Street is not democratisation, it is giving people an adrenaline kick by putting their savings at stake. All of this is reinforced by the current fiscal stimulus package, much of which may end-up being invested through these apps.


The dangers posed by individual trading combined with the increase of gig economy jobs and zero-hour contracts point towards a very unstable economy and employment market after the pandemic. The GameStop mayhem should be viewed as a call for action for regulators.

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