Small investors mounting an assault on Wall Street speculators suffered a setback on Thursday as trading platforms banned them from buying more shares in GameStop, spawning conspiracy theories, political intervention and at least one lawsuit.
Amateur trading app Robinhood stopped users from investing any further in GameStop – a US chain of video games stores – and seven other companies on Thursday, after an extraordinary rise in their value, spurred by users of the chat forum website Reddit, that cost some hedge funds billions of dollars.
The move slammed the upward surge in their share prices into reverse and sparked allegations that the hedge funds had wielded influence over Robinhood and other trading platforms to stop the rout.
The fallout even caused unlikely accord between opposite extremes of the US political spectrum, with Republican Ted Cruz and Democrat Alexandria Ocasio-Cortez both calling for a hearing into the decision to halt the trades.
It follows a meteoric rise in the share price of retailer GameStop and a handful of other stocks including Nokia, cinema chain AMC and BlackBerry, that began on the WallStreetBets page of chat forum Reddit, where users took aim at hedge funds making big bets against the companies.
As amateur investors piled into stocks that hedge funds had tipped to struggle or fail, the resulting rise in their share prices saw GameStop’s value hit $30bn (£22bn) at one stage - more than 100 times what it was worth in August.
This left Wall Street institutions, including hedge fund Melvin Capital, sitting on billions of dollars in losses.
But the decision by Robinhood and other trading platforms including Trading 212 – which is popular in the UK – to restrict users’ activity by allowing them to sell but not buy, removed the major catalyst for the WallStreetBets rebellion’s progress.
GameStop shares were down 44% by the end of the day, while the share prices of seven other companies caught up in the affair, including Nokia, BlackBerry, Trivago and AMC, also suffered big falls as share-buying was effectively halted.
Traders joining in the frenzy have flocked to Robinhood, an app which claims to “democratise” finance by letting ordinary people trade shares and more complex financial instruments, such as options. The trades are offered free of commission charges and the app, which was founded only in 2013, now has more than 13m users.
But the buying ban on the Reddit traders has sparked a furious backlash. Social media lit up with theories about hedge funds with an interest in the Robinhood company and other trading platforms flexing their muscles to quash the Reddit rebellion.
One customer has already filed a class action lawsuit in New York, according to reports in the US. As the backlash built, Robinhood said on Thursday evening that it would allow limited trading on the stocks on Friday.
Robinhood has previously faced criticism after a young trader killed himself in the mistaken belief that he had lost $730,000. The company cancelled its UK launch last year.
Such is the fresh concern about the potential effect of such platforms on stock markets that the White House and financial regulators have said they are monitoring the situation regarding GameStop and the other stocks in Reddit users’ sights.
A spokesperson for the UK’s Financial Conduct Authority said: “The FCA is aware of the situation and continues to closely monitor trading in UK markets. UK investors should take care when trading shares in highly volatile market conditions that they fully understand the risks they are taking. This applies to UK investors trading both US and UK stocks.
“Firms and individuals should also ensure they are familiar with, and abiding by, all regulations including the market abuse and short selling regimes in the jurisdiction they are trading in.”
The phenomenon has been fuelled by small investors not just buying shares but also options, a sort of leveraged financial instrument that forces others to also buy, ratcheting up the power of the transaction.
Pundits have expressed concern that many of the Redditors and small traders who bought stock enthusiastically will lose their money unless they get out quickly.
Neil Wilson, chief markets analyst for Markets.com, wrote: “It would appear there is a failure to understand that the only way to realise paper gains after this ramp (pump) is to sell (dump); and in so doing offload your unwanted stock on someone (the greater fool) who thinks it will go even higher.”
While day-trading investors could lose out, the more immediate result is that hedge funds such as Melvin Capital that bet against GameStop and other companies are caught in a “short squeeze”. The more the shares go up, the bigger the losses they face. They also have to “cover” their position – in effect betting on a continued increase in the share price to offset the losses on their previous bets against it.
Melvin Capital said it had closed out its position, crystallising losses, but several other hedge funds are thought to be yet to take the hit.
The affair has caused upheaval in the US financial sector, due to the unusual battle between a cohort of many thousands of small-scaled traders and multi-billion dollar investment houses.
“Sometimes the past year has felt as if we were living through a dream or nightmare depending on how you see it,” said Saxo Bank’s head of equity strategy Peter Garnry.
“The number of things that have turned upside down is breath-taking. The past week has added another dimension to the things that have structurally broken down.”
He said the wild market movements caused by the Reddit short squeeze on hedge funds could ultimately lead to new financial regulations.
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