“Dumb Money” upbeats “Smart Money”- 2
In the first part of this article, I covered the following segments —
- What is the business of GameStop and a brief peek into its financials?
- Events that lead to the price increase of GME stock from $17 per share to $483 per share within 2–3 days.
- Actions taken by different stakeholders.
In this part, we will discuss the following points —
- The reason behind such a rally.
- Are there any ways to prevent such events in the future?
- Can this happen in the Indian stock market?
The stock price of GameStop, Blackberry, and many others, sky-rocketed due to the imbalance between supply and demand. The demand for the shares was more than the supply. Also, many hedge funds shorted the shares and the number of shorted shares exceeded the outstanding shares in the market.
Many Reddit traders were just not buying stocks but also call options on these stocks. Buying calls requires much less capital, so bigger positions can be taken by small traders. These factors lead to a short squeeze.
But these are a micro factor, there are some factors which is beyond this. Those factors are listed below-
- Zero-trading commission — Before Robinhood, anyone who wanted to invest in stocks, ETFs, or options would be charged between $5 to $10 a trade. They also needed to invest a minimum of $500 to open an account. Robinhood has allowed anyone to open a brokerage account with no minimums or commissions, eventually forcing other brokerage firms like Charles Schwab, TD Ameritrade, and many others to follow. There were more than 10 million new retail trading accounts opened in 2019.
- When COVID-19 started people were locked down in their homes. Travelling was stopped completely. So, people diverted their time into the stock market. Earlier retail investors portion compared to large institutions in trading was less, but this pandemic changed the picture. Before the pandemic, retail trading made up 14% to 15% of equity volume; now, its share is more than 20%.
- The government of the USA has passed trillions of stimulus bills in order to help Americans to fight against COVID. But, a lot of stimulus checks make their way into the stock market. Some people consider the stock market as a casino and trade for fun. They consider it like a lottery.
- Easy access to options trading — Daily options trading has more than doubled since 2019 and it's led by retail investors as it’s free now. Also, the getting margin is easily accessible. For instance, Robinhood customers can borrow up to two times the value of the cash they’ve deposited. A $1,000 deposit gets you $2,000 in stock-buying power.
- Low-interest rates — There are few options available to the retail investors compared to the big players in the market for investment, like equity, bonds, ETFs, and cryptocurrency. In the current scenario, bonds are giving low returns and the millennials want to make fast money. That’s why the money is being flushed to the equity stock markets.
- It’s more personal — While going through some of the Reddit messages, I realized it’s less of GameStop and more of the feelings that people have against the hedge funds and fund houses. See some of the comments below:
A member of WSB wrote on Reddit that “GME is about sending a message. For all the recessions they caused. For all the jobs and homes people have lost. For all the people that can’t pay for college because minimum wage has stagnated while wall street gets rich. For all the retail traders they left holding the bag. For all the times they got bailed out with our tax money while we got nothing.”
Another comment was — “I am proud to be a part of this piece of history with you. Call it an opportunity, call it revenge, or justice, I know we are on the right side of this.”
Could this have been prevented?
This event may not be a revolution, but a revolt against wall street who have taken advantage of their position and misguided people.
- Many brokerage firms had stopped trading on these stocks, but it wasn’t their responsibility. The regulators should have taken this step. If you look at the chart below, trading halted many times in NYSE, but no halt was for more than 5 minutes under the Limit up/ Limit Down rule.
- Trading on margin should be reduced or more stringent requirements for complex trading strategies.
- The rules for getting into options should be more regulated. There is no restriction in terms of how large short positions can get on a stock. Approximately 140 percent of GameStop shares had been sold short.
- Brokerage houses can also educate their customers about the dangers of trading, especially with borrowed money.
Given the regulations put in place by the Securities and Exchange Board of India (SEBI), it is very difficult to carry out such trade in India.
- Most of the people who invest in the stock market take a long position, i.e. they expect the stock price to increase in the future.
- On the Indian stock exchange, an investor shorting a stock is mandated to buy back the shares and square-off the position at the time of settlement i.e. before the stock market closing.
- There are strong intra-day circuit breakers in India. Circuit breakers are pre-defined values in percentage terms, which trigger an automatic check when there is a runaway move in any security or index in either direction. The values are calculated from the previous closing level of the security or the index. The usual values of these are 2%, 5%, 10%, or 20%.
- In the US, brokers are allowed to lend shares to the traders. So, they keep shares in a pooled account, which makes lending possible. However, In India, the shares are kept in the Demat account of the particular trader, and brokers are not allowed to use them for lending
- Lending in stocks has to be done through an exchange platform called Stock Lending and Borrowing (SLB) mechanism. SLB is an exchange-traded product in India, settled by the clearing corporations, which means there is no counterparty risk. Adding to it there are only 350 stocks that fall under this category.
- Stocks that are eligible to be traded in the derivatives segment should have a market-wide position limit of 20 percent of the free-float market capitalization of a stock. A market-wide position limit is the maximum number of open positions allowed across all F&O contracts of the underlying stock.
Let's see how the modern David and Goliath story shapes the US stock exchange in the future.