The internet is on fire this week. What started as a fantastic trade thesis — that heavily shorted GameStop Corp. (NYSE: GME) stock was due for a major short-covering rally — appears to have morphed into an all-out street brawl. (I covered this earlier this week in Money & Markets.)
Street brawl might be the wrong analogy. It’s hailed more as a David vs. Goliath moment: A group of scrappy do-it-yourself value investors taking down an established white-shoe hedge fund … and one that happens to be funded by some of the most powerful names on Wall Street.
The funny thing is, Bitcoiners always talk about how they're engaged in some epic battle against traditional finance, bankers etc. even though that's a totally fabricated narrative.
WSB actually KO'd a well established hedge fund.
— Joe Weisenthal (@TheStalwart) January 26, 2021
Melvin Capital was the hedge fund in question, which happens to be financially backed by Citadel Securities and Point72 Asset Management, two of the largest and best-connected hedge funds in the world.
And here’s where it gets fun. At one point in the chaos this week, Robinhood — the brokerage app favored by many retail investors buying GameStop — abruptly halted new buy orders in the stock. Most of the major online brokers used by the investing public followed suit quickly thereafter.
This is not a situation where trading the stock was halted at the NYSE. That’s pretty common and can happen for legitimate reasons if the market has become disorderly or if the exchange or regulators suspect market manipulation. It also wasn’t a case of the brokers protecting themselves by tightening margin requirements. It’s not unusual for brokers to restrict trading on margin for stocks going absolutely bonkers. It happens all the time, and it’s perfectly normal. The brokers have to protect themselves from margin loans gone bad.
No, this was something else entirely. Trading in GameStop shares wasn’t halted. Trading was halted for only some traders while not being halted for others.
We don’t really know the details yet. Still, the Twittersphere is ablaze with accusations that the brokerage firms conspired to effectively bail out the short hedge funds by forcing the scrappy retail investors buying the shares out of the market. Remember, in this age of zero trading commissions, many online brokerage firms no longer make money on retail clients. They make money from order flow, which essentially means selling your information to larger investors potentially looking to take the other side of the trade. So, the thinking goes, the hedge funds leaned on the brokers to do them a favor.
I try to stay away from conspiracy theories, but something here doesn’t smell right. And it was enough to get the attention of Congress. Both Democrat representative Alexandria Ocasio-Cortez and Republican Senator Ted Cruz have called for investigations:
This is unacceptable.
We now need to know more about @RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit.
As a member of the Financial Services Cmte, I’d support a hearing if necessary. https://t.co/4Qyrolgzyt
— Alexandria Ocasio-Cortez (@AOC) January 28, 2021
Our two political parties can’t agree on much of anything, yet they find common ground in their belief that something dodgy just happened.
So, What Is the Takeaway From This Sordid Affair?
Well, there are a few things. As I noted earlier this week, you should be careful when shorting stocks. I don’t know how this ends, but the hedge funds and brokerage houses involved may ultimately find themselves in court or under a major SEC investigation. If they broke securities laws — and let me be clear that we don’t know if that is the case yet — they did so because they were scared enough of the potential losses to make it “worth it” to them. The hedgies were wildly irresponsible to take short positions as large as they did — putting themselves in a position to get squeezed. And the brokers were wildly irresponsible to enable it. Had they not been so reckless, none of this would have happened.
But perhaps there is a larger lesson here too:
The Gamestop thing is a reminder that investing is not the study of finance. It's the study of how people behave with money, and sometimes those behaviors are incredible.
— Morgan Housel (@morganhousel) January 26, 2021
A Larger Lesson to Learn From the GME Trade
Markets are ultimately driven by the people placing the trades, and those people sometimes trade for reasons that don’t appear to make sense at first. If internet chatter is any indication — and we should probably take that with a grain of salt — the mentality of a vendetta was at play here. Many Americans are still furiously angry that the bankers that blew up the world in 2008 were never really punished. Their risk-taking blew up the economy, and yet there were no real consequences. Or more accurately, the consequences were suffered by the rest of us.
Blowing up a hedge fund or two likely felt like good old-fashioned revenge to many of these traders.
I recommend keeping emotion out of it. Adam and I take a cool, rational approach to investing, but that didn’t stop us from profiting from a similar incident. In the December issue of Green Zone Fortunes, we chose a stock that, like GameStop, was heavily shorted by Wall Street and thus due for a major short-covering rally. Well, we doubled our readers’ money in a little over a month!
To find out more about this stock, and be the first to get monthly trade recommendations of our highest-conviction Green Zone Fortunes picks, check out Adam’s Millionaire Master Class here.
To safe profits,
Charles Sizemore is the editor of Green Zone Fortunes and specializes in income and retirement topics. Charles is a regular on The Bull & The Bear podcast. He is also a frequent guest on CNBC, Bloomberg and Fox Business.