Will Reddit beat Wall Street’s hedge funds?

Social networks increasingly influence the price of some financial instruments, but will Reddit beat Wall Street’s hedge fund? Can a bunch of Reddit users put wall street greats in trouble?

This article refers to spontaneous movements born on Reddit to beat Wall Street’s Hedge Fund, growing social networks. The story of the Reddit group in support of Gamestop has made it clear that a social network can influence the price of a stock, but who runs the game? Maybe the cat’s just playing with the mouse.

Twitter and Reddit are the social networks that young investors are especially following. When a stock or commodity becomes viral, the price’s volatility increases rapidly.

When a stock is small and illiquid, it will experience a lot of price movement. Liquidity always affects volatility in speculative markets.

If someone involved in the company tries to influence the price, the US Securities and Exchange Commission can step in. When Elon Musk tweeted about Tesla stock, it happened. 

Elon Musk social network tweet about Tesla price

The SEC doesn’t seem to be interfering with the Reddit groups right now, but they might later. Someone could undoubtedly pilot future initiatives to speculate on a stock.

However, I want to focus on bottom-up movements such as those involving GameStop or physical silver. Many anti-Wall Street movements were born on Reddit. For instance, a group of investors buys a lot of physical silver to increase its price.

Why are joint projects born? Are they piloted by someone, or do they happen? Is it possible to invest following these trends? Are people on Wall Street watching or taking advantage of this trend?

Let’s have a look at this new financial phenomenon and see what it means.

Why do movements take off on social media?

In this article, I don’t detail GameStop’s history; I refer you to this article if you want to learn more.

It’s happened and will happen again, so I want to understand the motivations that drive people to create a community to support the stock. They’re angry about resentment and hatred towards Wall Street, big banks, and hedge funds.  

group of reddit born to beat hedge fund in a gamestop battle

Hedge funds can bet on a stock going up or down and have enough money to make a significant impact.

When hedge funds target stock to crash, short-selling begins. If the stock is illiquid, the price will collapse in a short time. The price collapse will make short-holders rich and bring the company and its financial stability.

Everyone knows how the financial markets work, but sometimes they give the story a moral spin. In this previous article, I consider Gordon Gekko’s greed and thinking of the 80s, comparing it to today.

This hatred of the model materializes in a sort of war in which social media users buy a financial product in bulk to defeat Wall Street’s hedge funds. Most people who participate in the conflict don’t want to get rich or speculate. 

Reddit users have two main objectives: attacking hedge funds and defending the company, susceptible to short-selling. So there is a mix of hate, love, and compassion that arms people against Wall Street and what it stands for.

If Reddit’s movement is advertised correctly, it quickly goes viral and attracts many small investors and traders. The more the story spreads, the more popular it becomes, and the more people it attracts.

Can Redditors win a battle against hedge funds?

Are you wondering if a group of small investors can beat hedge funds? The answer is no; it’s like trying to kill Rambo with a toothpick.

Wall Street has infinite money, time, and other resources to make these kinds of conflicts drag on long enough to make even more money. If many inexperienced investors buy a stock, it’s because the same people who were shorting it are selling it to them. 

Look at the GameStop graph of the last period, a meaningless price swing with insane volatility. 

Conseguence of reddit war against wall street hedge funds
Chart by TradingView

When private investors buy a stock, more institutions will accumulate bearish positions. Hedge funds will use the options to hide their trades and make a killing when the stock plummets again. This technique is called short-squeeze and consists of buying put options as the price rises and, in the end, pushing the price to the downside.

Small investors can’t outsmart big speculators in the long run. The enthusiasm around these initiatives is unfortunately unmotivated because sooner or later, they’ll all end up against a wall. 

Governments would have the power to stop significant funds from driving down the market. But is it a good idea to limit the stock market after having pumped it up so much?

Is one fund that speculates on one share with a short position worse than another that speculates long? Is it more ethical to raise a stock artificially and not based on its value? I don’t think it will change much, but the stock market wouldn’t exist without these speculations. 

Limiting sales on stocks makes the market unsafe for investors; liquidity is what makes it safe.

Who gets rich from social network movements?

When the stock market moves based on social media, many people get rich. Brokers are the first to take advantage of this situation, of course. Lots of people are getting into online trading, and new money is coming into the market. Just think of the Robin Hood platform that attracts young people who’d never invest in the stock market through their bank.

robinhood broker download skyrocket thanks reddit war against wall street
Image from Bloomberg

Brokers earn regardless; the more trades are made, the more commissions they earn. For this reason, they love intraday scalpers, as I explain in this previous article.

Even private traders can make a profit. If you enter first, you’ll generally see the shares go up. Basically, at first, the share price rises and, if you sell at the right moment, you can make a lot of money.

Eventually, the hedge fund sharks will make their move and get a big piece of the pie when many have entered. 

Social networks and other websites will also benefit from these events by selling ads. Everyone benefits from the game in some way. The only ones who will lose their money are the latest investors, a bit like a Ponzi scheme.

The speculated company will probably not benefit, except maybe in terms of notoriety. No publicly traded company wants to see their stock on a roller coaster for months. The American market’s companies are financed precisely by shares, and volatility drives away non-speculative funds. For example, a pension fund wants to hold only stable stocks in its portfolio, and it will soon get rid of a stock that gains or loses 30% every week.

Conclusion

As I said at the beginning of this article, I trust the good faith of those who initially promote these initiatives. People who invest for moral reasons won’t sell when the stock has gone up because they aren’t in it to make a quick buck. So even those who joined at the beginning are likely to close even or lose.

Even though movements born on Reddit seem fascinating, they can’t beat hedge funds. David rarely beats Goliath in real life.  On the other hand, volatility will hurt the company rather than help it.

In the end, the conclusion is always the opposite of what was hoped for. People who want to take down the bad guys will lose their money, and the bad guys get rich. 

reddit vs hedge funds is like david vs goliath

The number of people doesn’t matter because Wall Street can print money, and it has an unlimited supply. People who participate in these skirmishes are unprepared and inexperienced and can only lose money. 

Moreover, it is wrong to attack face-to-face on a public channel where the enemy can know the opponent’s movements in advance. Financial markets have always worked in this way; there is speculation about everything. As long as the companies are publicly traded, someone will speculate on them in one way or another.

Getting rid of the stock market wouldn’t help anyone. It’s hard to imagine a world without finance. The whole system would collapse, and it’d be like mass suicide. 

Hedge funds aren’t always the bad guys; they were created to make money by buying and selling stocks. Like any other business, they make money from the market through supply and demand. If they’re not using illegal methods, I don’t think they can be called bag guys or criminals.

Follow me on Twitter LukkVal