On GameStop and dispelling the illusion of trading skill.
GameStop (GME) has been the subject of much controversy of late. If you’re out of the loop, a bunch of ‘traders’ (read: people with the RobinHood app installed) on Reddit have been buying a lot of GME stock, massively inflating the share price.
Currently, their plan is what is known in finance as a ‘short squeeze’ - they want to push the price up, causing those shorting GME (large hedge funds) to incur losses, making them sell their shorts, which inflates the stock price - to sell a short, you have to buy the stock.
Whether this will succeed is still up in the air, and I would read either Matt Levine or Alex Kirshner for better takes on this. Just note that a lot of financial commentators are presenting Reddit as a unified force - it is not. It’s a bunch of individuals who will likely panic if GME starts to take major losses.
Matt Levine is likely correct in his diagnosis - GME is a Schelling point - a focal stock for a bunch of people to buy and co-ordinate around without explicitly co-ordinating.
A lot of people are amused by the behaviour of redditors, some on Wall Street are outraged. A friend of mine comments that there is a massive degree of snobbery involved from those on the other side [see the bottom of this post for an example].
John Authers covers this in another post, and one interesting facet of this whole avalanche of trading is the hostility shown towards anyone in ‘traditional’ finance world. This isn’t just about GME, there’s a real sense of injustice. One user comments:
“These are the same kind of guys that got bailed out while people lost all their pensions and life savings in '08. I don't even care about the money anymore, I just want to know we actually made a stand and tried to make a difference if this doesn't work out.”
The Identity of a Financier
GME & the /r/wallstreetbets community in general seems to offer another shot against ‘Those In Finance’. Often traders, fund managers and analysts have some level of expertise in their identity. They pride themselves on their ability to see the fundamentals of a stock, and they pride themselves on their ability to work out why a certain movement happened, or why a certain movement might happen in the future.
Obviously you can Captain Hindsight here, in pretty much any way you want. “Stock X tanked because of Y” is the easiest statement in the world to make because Y can literally be anything - how would anyone prove you wrong? There are very poor feedback mechanisms in trading.
In the Jonathan Coe novel The Terrible Privacy of Maxwell Sim, a trader and somebody’s uncle converse at a dinner party about trading, and this dispute is at the crux of the argument. The trader wants to believe that they are skilled and do something no-one else could do.
This is a standard human fault, but it rarely has the kind of impact elsewhere that it does in finance.
To this extent, I’ve always thought a significant amount of trading tools (especially ones that are based entirely off a stock price’s recent movement - pivot points and bollocks bands to give two examples) are mainly designed to introduce complexity and to gate-keep other people from understanding what’s going on trading.
Besides, do we really want people to be trading purely off movements in a stock? I thought the idea was to buy stock based on its underlying value, and thus assign value to useful companies, not because the price is likely to be sticky at a certain point.
The community on /r/wallstreetbets show that stock prices often don’t move with fundamentals, something everyone in finance probably knows deep down. They move because of strange-faith based magic, that works erratically and dispenses misery at random.
And they don’t give a fuck. Many people in the community identify as (in their words) “retards” and “autists”.
It’s a point of pride to buy a stock you know nothing about.
They totally dispel the illusion of skill in trading.
These people are making millions, and they have no clue what they’re doing. After Tesla’s price surged around Christmas, one person on /r/wallstreetbets, who had made $3 million betting on Tesla (a bet he made because the cars “looked cool”), who decided he was going to take out loans against this volatile equity, because that’s “what rich people do”.
Here’s one commentator on Reddit attacking Melvin Capital (an investment management company shorting GME):
Imagine spending all that time and money “modelling a lot of companies in significant detail” with a “lot of analysts”, only to be bankrupted by a bunch of illiterate[s] trading on their iPhones with cracked screens bought by their wife’s boyfriend. I have all the analysis that you need right here melvin: stonks only go up 🚀🚀🚀
Daniel Kahneman at one point compared fund managers abilities to a coin toss - but /r/wallstreetbets makes this a visceral reality, and it is an unpleasant reality for anyone who prides themself on their financial abilities.
Some out there would probably try to argue this is a temporary blip, and such recklessness will eventually be exposed by the ruthless efficiency of the market - paging Eugene Fama - and many of these people will lose their all of their money. Trading famously has a 90-90-90 rule - 90% of new investors lose 90% of their money in 90 days. RobinHood traders have already lost millions.
Those In Finance
And ‘Those In Finance’ will win again. Is the reason that hedge fund employees succeed because they are much smarter than everyone else? Unlikely. There are very poor feedback mechanisms in trading, as I mentioned above, so there’s little room to actually learn skills. The education literature is very clear on this: to become an expert, you need feedback mechanisms.
In addition, if you’re working with much larger capital pools you can get larger returns for lower risk. If I start with $1000, and I make a 20% return in a year (a tough ask), I get $200. If I do the same with $10,000,000, and I only make 10%, I make $1,000,000.
Trading reminds me of trying to solve cryptic crosswords - there’s a bunch of rules and systems in place to solve the clues, and you have to know the rules or you can’t do anything. But the key difference is that being able to do a cryptic crossword doesn’t affect other people’s lives.
On a broader level, why should a system, designed nominally to allocate capital efficiently, allow this kind of rampant speculation?
That’s not aimed at regulating Reddit - what hedge fund employee on 300k a year is donating their winnings to charity as the stock goes up? - but at the system more generally. Reddit is the tiniest fraction of the market.
The majority of speculation and profit taking is coming from hedge funds and banks, not from random redditors with $3 seed capital. People in hedge funds make money while Coronavirus shreds the economy (stocks at a discount, baby). In the age of zero interest rates and free capital, the system is likely to be less allocatively efficient than ever.
Currently, Morgan Stanley is engaged mainly in the practice of wealth management, which seems to differ from prop trading in that it transfers risk to the client, and so all of Morgan Stanley’s risk disappears. Morgan Stanley make money by taking a fee for managing your money.
James Gorman, Morgan Stanley’s CEO, made $33 million this year, apparently off fees taken for managing people’s money. Inequality continues to thrive, and yet it has disappeared from the agenda recently - perhaps because everyone got so bored of hearing about inequality and yet seeing no action being taken to remedy it.
And if we’ve reached a point where returns to capital are so consistent and effective, that Mark Blyth is advocating governments to just create sovereign wealth funds and exploit the free 6% return, are we really in the optimal system?
Let’s make some taxes on speculation happen, for a start.
Here’s Brandon Kochkodin engaging in a bit of said snobbery:
It’s a little known fact, and one that you wouldn’t expect to learn on a Reddit message board, that a stockholder can request that shares they own outright not be lent out to short-sellers.
Here’s the “Reddit message board” telling people exactly that information (a more upvoted post has since been deleted):
Now, anyone who uses a margin account basically agrees to have their broker lend your shares on their behalf anytime. You have to explicitly stop your broker from lending out your shares [to shorts].
People on /r/wallstreetbets regularly refer to their wife’s boyfriend. As with any gag on an internet forum, it’s gone through so many iterations as to have an indeterminate source, but it’s something to do with going bankrupt so spectacularly that your wife starts cheating on you.
Stonks is another word for stocks.
🚀 is a rocket ship - used to indicate a particular stock is going to the moon (you guessed it, up).