Prepare for more ‘Reddit rebellions’

The rise of ‘free’ stockbrokers and the power of social media forums mean a GameStop-style trading frenzy could happen again. Sam Benstead explains how it changed the investment world and what savers should do now

Two weeks of Hollywood- style stock market drama have ended with a bang – but the social media uprising against Wall Street could have long-term consequences for investors.

The “Reddit revolution” began as an organised bet on GameStop, a cheaplooking and seemingly past-its-best video games retailer, but turned into a historic attack on hedge funds. Momentum built, attracting the attention of punters looking to make a quick profit.

The frenzy peaked when stockbrokers around the world buckled under the trading pressure and blocked investors from buying shares. When they reopened this week, the targeted stocks crashed, leaving investors late to the party nursing big losses.

Shares in GameStop soared from $17 at the start of the year to a peak of $483, a 2,700pc rise, before they crashed by 80pc as investors backed out of the stock.

It was a boom and bust for the history books, showcasing how greed and fear, the two forces at the heart of every market move, could combine with the network effects of social media and modern day discontent at wealth inequality. explains what

‘The next rocketing stock will be on Reddit first – but it will come crashing down’

happened, why it matters, and what lessons investors should take from the Reddit stock trading frenzy.

WHY DID IT HAPPEN? The power of social media to organise strangers behind a common goal made the GameStop boom and bust possible.

Reddit, the online forum, has 400 million active users, all participating in “subreddit” groups that discuss topics ranging from funny photos to politics. The WallStreetBets page now has 8.5 million members and is a hub for investment ideas.

Momentum began to build about the possibility that GameStop, a bricks and mortar retailer in America, was grossly undervalued and could turn around its fortunes. It was also heavily “shorted” by hedge funds that were betting against the shares.

To do this, the hedge funds borrowed GameStop shares and sold them in the hope that when they had to buy them back to settle their debt, the share price would have fallen, making them a profit.

They did this in such numbers that Reddit users realised the potential to drive a “short squeeze” by buying the shares, sending the price higher and forcing hedge funds to close their short positions as losses spiralled, creating even more buying pressure.

Free trading services, such as Robinhood in America and Trading 212 in Britain, made it possible as investors could take part without paying stock trading fees, while the ability to bet with borrowed money via “derivatives” on some platforms allowed investors to amplify their bets on the stock.

Brokers reported a surge in sign-ups as the GameStop story lured younger investors into the stock market. The number of 18 to 24-year-olds who joined Interactive Investor, one investment shop, in the last two weeks of January was more than 1,000pc higher than in the same period last year. But it wasn’t just a millennial movement: GameStop was most popular with the broker’s customers aged 35 to 45.

The scope for the herd to chase an idea had never been stronger. Combined with a Main Street versus Wall Street narrative, it created a power keg primed to explode if enough investors took part in the trade.

Many believed they would crush the hedge funds and make money for themselves. Others bought into the “greater fool” theory that they would be able to get in and out quickly enough by selling their shares before the price crashed.

WHY DOES IT MATTER? The collective action of Reddit users affected everyday investors – and it could happen again. Investors in index funds, which own small stakes in all companies that belong to a particular stock market index, unwittingly owned some of the targeted shares. GameStop became the second-largest holding in BlackRock’s £45bn iShares Core S&P SmallCap exchange- traded fund, making up 1.1pc of the portfolio. BlackBerry, another share targeted by Reddit users, is the joint fifth- largest holding in the L&G Cyber Security ETF. It looks after £ 1.8bn of investors’ cash – of which almost 3pc is invested in the internet security firm. The fund rose by about 10pc as BlackBerry quadrupled in value, before both fell back. Ben Yearsley, a financial adviser at Shore Financial Planning, said a fund that held more than 5pc in such stocks should merit concern, but funds shouldn’t be bought and sold on the basis of smaller stakes in a single share.

But the impact of the Reddit trading phenomenon stretched far beyond a cluster of out- of- fashion American stocks. A rallying call to drive the price of silver, a $1.5 trillion market that accounts for a much more substantial portion of pension funds, succeeded in creating a spike, even as it was disowned by other Reddit users.

Global stock markets were thrown off balance by the GameStop phenomenon as investors feared that losses on short positions would force hedge funds to sell other shares, sending prices lower. On the London stock market, shares in Pearson, Cineworld and Petrofac jumped as hedge funds dropped their bets against the stocks.

Henry Rochford, a 23-year-old WallStreetBets follower from Southampton, said the impact of social media on the stock market was here to stay. The next big short squeeze or rocketing stock would probably be highlighted on Reddit first, rather than behind closed doors in the City or on Wall Street, he said.

“As long as you get out fast enough you can make lot of money by following Reddit forums – but it will come crashing down,” said Mr Rochford.

WHAT NOW? Professionals advise against trying to buy and sell the next viral stock. Russ Mould of AJ Bell, the investment shop, said these trading rushes had nothing to do with companies’ business models or financial strength.

“GameStop has been, at best, a trade rather than an investment or a stock to own. At worst it has been a gamble, with investors just betting the shares would keep rising. Those involved need to make sure this fits with their overall strategy and risk tolerance,” he said.

Mr Mould advised investors to ignore the siren song of quick profits and stick to a long- term strategy regardless of which stocks were in fashion.

This was particularly important for younger investors who might be attracted by the GameStop phenomenon, who had years of investing ahead of them. “Compounding returns over long periods is extremely powerful for young investors,” he said.