New investors moved to the stock market in droves last year, many pressured on social media platforms where others were crowing about winning big.
Now, the role that forums like Reddit’s WallStreetBets played as rallying points to boost stocks has the attention of regulators as they investigate the trading frenzy in shares like those of GameStop Corp. Coupled with new trading technology, social platforms are giving ordinary investors a way to battle with Wall Street insiders.
The House Financial Services Committee is scheduled to hold a hearing Thursday to investigate the volatile trading of GameStop, and the role hedge funds and online brokerage apps played. The list of witnesses for the hearing hasn’t yet been released.
Several lawmakers have already sided with the retail investors in public remarks. The role of social media platforms, though, has drawn little attention. The Securities and Exchange Commission is examining posts on the Reddit forum for signs of fraud and corresponding trade data that could show an attempt to manipulate GameStop’s share price, Bloomberg News reported on Feb. 3. SEC spokesman Ryan White declined to comment.
Retail investors coordinating on WallStreetBets bought up shares of GameStop, a brick-and-mortar retail chain last month, at least in part to target hedge funds that had aggressively gone short, a practice in which they bet that a stock’s price will fall. When the price rose instead, those funds were forced to buy more shares, which helped push the price to more than $400 a share from about $20 at the beginning of the month. After the dust settled, the price fell to around $50, where it has been for much of February. Retail investors who bought near the top have been hit hard.
Michael Woodhull, a bartender in New Orleans, said he started following the WallStreetBets subreddit late last year. Woodhull, 30, credits it with providing a free financial education.
“My financial literacy two years ago was basically nothing,” he told CQ Roll Call. “There’s a lot of really smart people on there, and there’s also a lot of ‘trolls,’ which makes it a great source of information. You have people having these conversations and you can see stuff explained. They helped me a lot even on just basic definitions.”
Woodhull said he followed the GameStop short squeeze as it unfolded on Reddit and got out before the bubble popped with about $4,800 in profit.
Angela Fontes, a behavioral economist at the research institution NORC at the University of Chicago, said new investors like Woodhull flooded the markets last year. The investors tended to be younger, more diverse and likely to trade in smaller amounts, according to a study co-written by Fontes and released through NORC and the Financial Industry Regulatory Authority.
They were also more likely to turn to social media when making investment decisions, Fontes said.
“One of the striking findings was that about 14 percent of our new investors said that they were getting information from social media, where about half that — 6 percent — of our traditional investors were getting information from social media,” Fontes said. “There’s a social aspect happening for new investors that doesn’t seem to be there for more traditional investors.”
Steven Jensen, who works for Orleans Coffee Espresso Bar in New Orleans, said he began investing when he noticed the market tumble last February. About a quarter of new investors surveyed in the NORC study reported the same motive.
“A lot of people I knew were like, that was the time to buy stuff. Everything’s so cheap, and I didn’t have an account,” Jensen told CQ Roll Call. “Basically after that is when I started.”
Jensen, 34, trades through an online investment account app run by Webull Financial LLC, which allows users to open accounts without a minimum deposit and trade without fees. The phone app lets him track the market and execute trades during lulls at work, Jensen said. He buys or sells stocks most days.
When picking companies to invest in, Jensen said he relies on social media including Reddit and the platform StockTwits, as well as comment sections on Webull and public information about a company, such as the price to earnings ratio or date of the last stock offering. He said he doubled the $6,000 he started with last year.
Following the herd
Xing Huang, a professor at the Washington University in St. Louis Olin School of Business, said GameStop activity was an extreme example of retail investors’ tendency to “herd” around a few stocks.
In a study Huang co-wrote and released this year examining investor trading behavior on the online investment app run by Robinhood Markets Inc., her team found that Robinhood users tended to focus trading on a small group of stocks.
New investors tend to be more susceptible to coalescing around a particular stock in general. But Robinhood users proved even more likely to do so for volatile stocks, Huang and the other researchers found. The app’s streamlined design, which includes less information about stocks than its competitors do, likely drives customer attention to a few companies, they said.
“Social media is a very good mechanism to coordinate people’s attention. It adds another element, which is the peer factor. When you see other people make certain choices, you tend to mimic their behavior,” she told CQ Roll Call in an interview.
Wall Street firms have also caught on to retail trading patterns and profit from them through short selling, Huang said. Heightened attention from retail investors drives up a company’s share price temporarily before it usually returns to its fundamental value, she said.
“There is an incentive for hedge funds and institutional investors to short on those stocks,” Huang said, adding that the research showed increased short interest for stocks that Robinhood investors favored.
Will McCormack, a 26-year-old emergency medical technician for New York Presbyterian Hospital in New York City, said he turned about $2,500 into $25,000 by trading GameStop. McCormack got into trading about three months ago because he had extra cash. He plans to steer clear of the WallStreetBets Reddit forum in the future.
“The thing about WallStreetBets is I had been aware of it, but I had been aware of it kind of in a negative connotation. I felt like they didn’t really know what they were doing,” he said, noting the GameStop frenzy drove its membership to 9 million people. “I’m not really sure how the community is going to evolve with that kind of influx of new people who in all likelihood don’t know very much about the stock market.”
John C. Coffee Jr., a professor at Columbia Law School, said the most faithful adherents to GameStop who are left holding the bag may be less enthusiastic about attempting a similar gambit.
“They’ve just had a very painful education. I don’t know that they’re going to be able or willing to do this again in the near future,” Coffee told CQ Roll Call.
But he said there’s not much need to crack down on coordinating on social media, unless registered financial professionals who participate on those forums are doing wrong, Coffee said.
“We’ve got not so much an evil conspiracy as a cult of worshippers of GameStop. People who have extreme enthusiasm are not inherently committing fraud,” he said. “The agencies only have jurisdiction over fraud.”