What are hedge funds and how do they affect the market?

Hedge funds are a type of investment vehicle which pools money from the wealthy. They are known for lending the big firms a hand to perform high-risk investing maneuvers. Now, you need to understand what ‘short-selling’ means.

When you ‘short a stock,’ you bet for that firm’s prices to fall in the market. The moment you buy the shares of the company, you sell them, and when the prices begin their descent, you repurchase their shares, allowing you to pocket the difference in price as your profit. But if the prices are on the rise, then you are in serious trouble.

Here Comes the Main Star, GameStop

It is essentially a brick and mortar store that sells video games, hardly a business to be in right now. Some investors believed the company was in desperate straits, and the company’s stock had been trading at $10 during the fall of 2020, although it had been trading at around $4 for the most part of the year. Investors, being confident that the price will fall again, shorted GameStop.

Now Comes the Role of Reddit

We all know what Reddit is – a chat room that is broken into groups based on different categories, called subreddits. This one subreddit known as r/WallStreetBets is at the heart of this affair. They are known to post about their investment activities, both good and bad, without any filter.

Some of the members from this subreddit viewed this as an opportunity to take on what is commonly perceived as Wall Street’s greed for what is called a short squeeze, when they caught wind of the shorts placed against GameSoft.

Now see what happened when they heard that? The members started buying the stocks, driving the prices up, knowing full well that this could potentially cause a multimillion-dollar lose for the hedge funds who shorted on this stock, forcing them to repurchase the stocks at an inflated price.

The hedge fund began to lose billions as there was no difference to pocket because of the stock value now being higher than they originally purchased it for. The value needed to be returned as it was borrowed as a short trade.

The WSB members were able to maintain the high prices almost throughout the week, inflicting more pain to the hedge funds who placed their bets against low prices. This gained a lot of attention through social media and news networks and made other investors join the club and influence the prices in the stock market more.

The hedge fund finally had to close its short position and buy back all the stock at a much higher price. This resulted in the GameStop stock soaring – a great example of “short squeeze.”

On January 28, a handful of brokers restricted retail investors from trading in several stocks, while the other financial institutional investors carried on, as usual, this ended up adding fuel to the fire between Reddit and Wall Street.

But on Thursday, many of the GameSpot shares were sold off, despite some members of WSB asking the investors to hold them for a bit longer. GameSpot shares closed down at 44%.

Should Investors be Worried About Their Investment?

Although this whole debacle will hurt some of the investors, most likely, it will not be you – that is if you weren’t involved in the saga. The ones who are going to lose the most from this are the short traders who were forced to cover their positions and investors who raised the price bar high.

According to the President of Odyssey Group Wealth Advisors in Lancaster, Pennsylvania, Aaron Sherman, “An average stock investor should not be impacted by this if they maintain a well-diversified portfolio which appropriately reflects their risk tolerance.”

He further adds that this makes it a clear example of why investors need to maintain a diversified portfolio and not center around a few individual stocks.

The best way investors can achieve market gains through limited volatility is by investing in low-cost stocks that are not likely to be influenced by abnormalities in the prices of one stock or the other. Taking part in the market short squeeze is a pure gamble, and healthy investors should not make this a strategy towards retirement goals.

Wall Street vs Reddit

Everyone knows hedge fund investors are not the most liked people out there. The huge losses in the stocks bought on by WSB members saw one of the best days for overall stock markets, as well as for Reddit.

The pushback from brokerage institutions like the Robinhood, to limit the buys has been criticized by many making most people feel as more power is handed over to the bigger institutional power at the expense of amateur retail investors. Many people have quoted that there is nothing wrong with taking advantage of a short squeeze when positions are being met.

The top Democrats on the House and Senate committees are overseeing this cause, and both have reported they intend to hold hearings on this matter.

Rep. Alexandria Ocasio-Cortez (D-N.Y.) Tweeted “Blocking retail investors from purchasing their stock while the hedge fund owners are free to trade the stock as they deem fit. This is unacceptable,” she further states that as a member of the Financial Services Committee, she is in full support of a hearing.

The hedge fund had to file for bankruptcy and this fueled other funds to call for regulation so that the public won’t be allowed to influence the market in this way. The Millennials and Gen-Z are often criticized for their lack of collectivism and interest, but this was a great example proving otherwise.

Conclusion

Young investors are among the most innovative, finding new ways to capitalize on the systems that confine them. But their dedication to sustainability and social justice is given equal weight to their exploitation of the neoliberal capitalist model.

This is not just the beginning; take the recent Wirecard scandal, for example. We haven’t seen the end of Reddit vs. Wall Street, and we’ll be seeing this phenomenon develop and shape the market over the coming months.