B Invested

How The Gamestop Saga Shone A Light On Market Manipulation

The billionaires were bawling into their beluga caviar recently, after a group of day traders got together on social media site Reddit and decided to inflate the value of a struggling stock and wreck the party of the hedge fund managers betting against it.

It was dubbed a modern Robin Hood story and even known as the ‘Meme War’, but what was the Gamestop saga and what does it tell us about manipulation in the market?

What is Gamestop?

Think about Video Ezy… seen many of those lately? Sure, we all love movies, but no one hires videos anymore. After Video Ezy went down, it wasn’t all that long until EzyDVD went the same way, going from a peak of 70 physical stores in Australia in the mid-2000s to the shrunken down online retailer it is today.

Well Gamestop is a similar bricks and mortar store for video games … another relic of a bygone era. These companies last longer in the more sustainable USA, but they limp along until they eventually disappear. So for now, Gamestop, which was forced to close hundreds of stores last year due to poor sales, is still listed and its performance on the market is consistently bad. This means that hedge fund managers regularly bet against it (or short its stocks), for safety.

So imagine their surprise when Gamestop shares soared by 1,915% last month, squeezing the hedge funds betting against it and costing them estimated losses of around US$19 billion in just a couple of days.

So what is short-selling?

Imagine someone borrowed your bike for the weekend. Meanwhile, a whole bunch of their friends borrowed other people’s bikes. Then, unbeknownst to you, they sold them all on Saturday, causing the value of bikes to plummet, before buying them back for less money on Sunday. They give you the bike back on Monday and keep the profit they made.

This wouldn’t happen in real life but it does in stock markets, where sentiment can fluctuate prices. The hedge fund borrows the Gamestop stock and sells it. The increase in selling of the stock affects sentiment and the value falls. The fund manager then buys the stock back at the lower price and gives it back to its original owner. The buyback sees the price recover and everyone is back to square one…except for all the poor hoodwinked folk who had to sell the stock back at lower prices. It’s a classic case of the wealthy manipulating markets to suit themselves. And Gamestop is the perennial battler; the most shorted stock on Wall Street.

The squeeze is on

Fed up with the “good old boys” of Wall Street, traders rallied together on the subreddit thread WallStreetBets and decided to buy up big on Gamestop stocks, sending its value soaring, costing the big guys big bucks and winning big in the process. One investor even turned $50,000 into US$47 million.

It resulted in a “short squeeze”, where the stock price begins to climb. This forced the hedge fund managers betting against it to go ahead and buy it back in order to put a stop to their climbing losses. That buyback then pushes the price even higher.

Shenanigans as traders frozen out

There was outrage in US Congress and across the world when trading app Robinhood and other retail stock trading companies intervened in the squeeze by freezing trading from certain retail investors, but allowed hedge fund managers to continue to trade freely.

It was seen as another example of the rich looking after the rich and restoring the status quo, despite the fact that the hedge funds behaved questionably in the first place by short-selling, costing ordinary people their money and enabling the market volatility that was eventually exposed.

Executives from trading app Robinhood, investment manager Melvin Capital and hedge fund Citadel are expected to face a Congressional hearing next week to account for the trading freezes. Robinhood is alleged to have links to Melvin and Citadel and is suspected by some to have acted in its own interests by protecting them with trading freezes.

Bustle in the hedgerow

The effect on the market was that these hedge fund managers realised they were no longer as safe to do as they wished. Once upon a time it would have been near impossible to mobilise a mob attack like this one, but nowadays the world is so connected by social media, that it can happen instantly. And it shows that Reddit and other platforms are no longer populated by a bunch of procrastinating youths. There are now sophisticated investors ready to pull off a mammoth squeeze at any time. Seasoned investors have been forced to look at how they go about their business and what may need to change.

So all’s well that ends well?

Not exactly. The restrictions on traders were later lifted, but the damage was done. Gamestop’s market value has since plunged US$30 billion, from its peak of US$483 per share on January 28, down to around US$50 at time of writing, a 90% fall. However, big investors appear to have learnt some kind of lesson, with a notable decrease in those betting against the stock. 

What’s your takeaway?

If this has taught us anything as investors, it’s that we need to be wary of being a pawn in a chess game. Governments, banks and big business can pull strings and manipulate markets whenever they see fit, which is why it’s important to get a strategy in place to live life on your own terms. This story was a perfect example of why retail investors are turning to things like Bitcoin. It’s decentralised and unable to be manipulated.

At Binvested, most of our clients follow Nathan Birch’s philosophy, investing in affordable properties, purchased below market value, with upside for growth and good rental income to promote cashflow. Building a portfolio with many of these properties in different markets offers you a good level of protection from the manipulation of others.