In recent weeks, volatility in the stock market occurred from large-scale retail purchasing of certain stocks by users of internet trading platforms such as Robinhood. This has led to questions on how the situation occurred, who was involved and how it may influence market regulations.
It started with short sales, said Mark Guthner, associate professor of professional practice in the Department of Finance. When investors believe a company’s stock is overvalued and will go down in price, they may borrow shares of the company’s stock from a broker and sell the shares to drive the price down, he said.
The investors then buy back the stock at the lower prices they helped to create, ultimately profiting from the falling share price, Guthner said.
“Instead of ‘buy low, sell high,’ you sell high and hopefully buy low,” he said.
In the recent situation, hedge funds, or partnerships between a fund manager and investors who use pooled funds to gain returns, short sold large quantities of GameStop stock.
Community members noticed investors were short-selling this stock heavily and began to drive the price up by buying it, Guthner said. This action from the Reddit community r/WallStreetBets (WSB) caused many hedge funds to experience heavy losses.
In addition to GameStop, Reddit users turned to short-sold stocks such as AMC Entertainment Holdings to further impact the stock market. Through Jan. 27, GameStop was up 1,745 percent and AMC was up 839 percent, according to an article from MarketWatch.
“It's historic … because it's a new group of people participating in this in a new way,” Guthner said. “This is social media, organizing people in a way that hasn't been organized before.”
Other members of the Rutgers community have been tracking the events that started on the Reddit forum as well.
Thomas Babiak, a Rutgers Business School junior and co-director of the Bender Trust Project competition at the Little Investment Bank of Rutgers, said he had been following postings on the WSB forum since last summer, where users claimed evidence for their short sale strategy and posted screenshots of GameStop holdings in excess of $50,000.
He said hedge funds trying to cover their short positions, or buy back the shares they had borrowed, and the amount of media coverage the market volatility garnered may have increased stock prices further.
The “bubble” surrounding the GameStop stock has since collapsed, and the stock is now worth a fraction of what it was during its peak, according to an article from The New York Times.
Still, Babiak said “meme stock” mania has taken over the market beyond stocks to include cryptocurrency, such as Dogecoin.
“People are going further and further out onto the risk spectrum, throwing caution to the wind, and there's a story around everything,” Babiak said.
Dhruv Parekh, a School of Arts and Sciences senior and co-president of the Rutgers Economic Society who has also been following WSB, said he could never have imagined something like the GameStop phenomenon occurring.
“I think it's really amazing to see the power this has given to the people and … the boom of retail investors,” he said.
Parekh said he had concerns about the decision of Robinhood, a popular stock trading application used by many retail investors, to temporarily restrict the buying of certain stocks on its platform, such as GameStop and AMC Entertainment Holdings, following the event.
He said while retail buyers could not purchase certain stocks, financial insiders were free to continue trading as usual. Douglas S. Eakeley, an Alan V. Lowenstein professor of corporate and business law at Rutgers Law School, said this raises the question of whether market manipulation took place.
Robinhood now faces approximately 30 pending lawsuits charging market manipulation, which he said will explore whether the platform was complicit in giving hedge funds advantages over retail investors.
The retail investors hoping to seek damages from Robinhood have two initial legal hurdles, Eakeley said. First, the plaintiffs must demonstrate to a court that their complaint is eligible for relief under federal law, and second, the class must be certified as class action by a federal court.
“If you get to there, you will have a great deal of power, and that could provoke settlement discussions at an earlier stage, but we’re a long way away from those two eventualities,” he said.
Sam Chawla, a School of Arts and Sciences sophomore, said he supports a free and open market while also understanding the pitfalls created by platforms like Robinhood.
“The new American dream is to be an investor, and Robinhood has really brought that to life,” he said.
Robinhood’s platform is easily accessible to individuals new to buying stocks and makes the process easier, Chawla said. Though, experts like Guthner urge inexperienced investors to exercise caution.
“Good traders are not afraid to take small losses,” Guthner said. “What happens is inexperienced traders are the ones that take big losses because they think things will turn around and then it doesn't, and then they ride it all the way down to the bottom.”