Stick It To The Man: Perspectives On Reddit’s Retail Traders
Revenge Of The Reddit Retail Trader? History Says No
It’s impossible to go anywhere now without hearing, or reading about Gamestop, Reddit, and short squeezes. In normal times it would be close to impossible for these 3 names together, to reach the international consciousness.
But these are not normal times.
Put yourself in the shoes of these new traders participating in the rollercoaster markets of Reddit targeted stocks:
The heady rush of euphoria from making a lot of money very quickly. That sense of we’ve-got-each-other’s-backs camaraderie from their fellow Wallstreetbets subredditors.
The sense of moral certitude of having a well known Congresswoman take their side when their brokers impose restrictions on their trading.
The vindication of having the brokers reverse their restrictions in the blink of an eye.
All. That. Adrenaline.
These folk must feel invincible! What can possibly go wrong?
Everything.
The market does not care about what is right or wrong, moral or immoral, logical or illogical. The market only cares about greed and fear.
The irony is that these same traders, the ones storming the halls of the market’s most shorted stocks are the ones who should know this best. Unfortunately, every time the word “should” is used, it tends to mean that something not very pleasant has happened, or is going to happen.
Why? Because the very purpose of their collective action was to scare shorts into covering, and if you feed a market that is too heavily short with fear, price skyrockets. If they didn’t know this before, they definitely know it by now.
Sadly they will not see it from this perspective, if they ever do, until it is way too late.
They won’t because of the emotions and adrenaline coursing through their brains right now. They won’t because they are inexperienced; and most of all, they won’t because of their greed .
And if you feed a market that is too heavily long with fear… what do you think happens?
Many will say this time is different, or that no one knows with certainty that this unpleasant thing will happen. The former statement has, through the centuries, become very famous last words of many a trader; while they will have a point with the latter statement.
But life doesn’t exist in certainties, it exists in probabilities, and history says the probability is pretty damn high.
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How Bubble Traders Sow The Seeds Of Their Own Destruction
There is nothing wrong with making a quick buck in the market. Although the real issue in times such as these is not whether one can make a quick buck; it’s if one does make a quick buck, what next?
Ultimately the folk rushing headlong into the most gut-wrenchingly volatile stocks in BubbleMania 2021 Edition are, for worse or much worse, inexperienced traders.
The sad truth is that most of the people who make money, even a lot of money, in these heady days will go on to lose it. It’s even possible to quite accurately predict how they will lose their massive winnings.
1) They left it as paper gains and rode the price tsunami all the way up, and then all the way down. Why wouldn’t they sell out as prices kept running higher?
Because they kept thinking that prices would rise even higher. Even as the stock is down 20%, they think 20% is nothing given the volatility seen in the previous weeks.
Now the stock is down 50% and their emotions take over with: “no pain no gain!”, “winners don’t quit!”, and ride it all the way down.
2) They refuse to sell out even as prices turn down and the market notches a few big down days in a row.
Why wouldn’t they sell out as prices started crashing back from the moon to earth?
Because they kept thinking that each successive low was a chance to buy more, and even if they did not buy more, they believed that others would come in to buy.
If people were buying at $200, and the stock went to $300, SURELY now that price is at $150 it’s a bargain! BUY BUY BUY
3) They took profits on their position, and then saw the market continue to surge.
Armed with a much larger trading account, they take a much larger position than before, thinking they can ride the market up again… only to find themselves in scenario 1 or 2.
4) They took profits on their position, re-entered, made even MORE money, and sold out again.
Confidence is sky high now, it’s almost as if God himself anointed the trader to be the Hero of the Market. So the trader goes long again, and comes face to face with scenario 1 or 2.
FOMO, it truly is a powerful thing.
Adding fuel to the whole situation is the fact that all of these folk also have to deal with the euphoric high of making more money than they ever thought possible, in the span of days.
Turbocharging this euphoria is the herds of other new buyers stampeding into their position(s). The feeling of being rushed along with the crowd while watching one’s PnL continue to skyrocket is pure exhilaration.
One feels on top of the world, that one can never be wrong. And that’s when the trouble starts.
Markets do not care about right or wrong. The same ruthlessness they applied to squeezing the shorts will be turned back on themselves… by themselves.
After all, the inexperienced people who, in this late stages, bought stock to get long, did so from other inexperienced people swept up in the current mania. And when the tide turns, as it inevitably does and these longs sell, it will be once again to other inexperienced people who still believe that the market can do nothing but shoot higher.
Ultimately, BubbleManias sow the seeds of their own destruction.
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Why It Sucks To Be A Regulator Right Now Part 1
The recent Reddit rampage through stock markets has brought the issue of fair access to trading capital markets to the fore.
While the anger has been directed at institutions, there is a broader issue at play here for regulators; which is that they, as a matter of policy, routinely shut retail out of accessing trading/investing opportunities.
They do so based on their criteria of determining whether an individual investor can be considered to be a “sophisticated investor”.
In practice, this really is nothing more than gating retail according to their net worth. Which begs the question:
How does being rich automatically qualify one as financially “sophisticated”?
It might not be so bad a measure if the individual in question is a business owner. Simply because business owners have taken risk, and understand the nature of winning and losing in competitive markets.
Even then, business settings are very different from duking it out in the financial markets, where rational analysis is just a thin veneer of sophistication covering what is underneath, very much a blood sport driven by fear and FOMO.
But if the wealth was simply inherited?
Then the net worth criteria really ceases to be effective. After all, what’s the difference between a rich guy with no experience taking risk with a poor guy with no experience taking risk?
The only plausible reason regulators have to gate by net worth is that rich people can “afford” to lose the money, which does make some sense. Regulators don’t want people to lose such substantial amounts relative to their total assets that they lose their house and can’t afford to eat.
But who’s to say rich people can’t lose all they have and more in markets? It has happened before and it will happen again.
If “sophistication” is to truly be an individual’s understanding of the true nature of markets and how they really function, the criteria for net worth should be set to $0. This is due to the fact that the ones who learn the harshest lessons in the market are the ones who did not survive it.
After all, the saying does go: “There are old traders, and there are bold traders. There are no old and bold traders.”
Of course this means that regulators need to devise a robust way of identifying which of these now considerably poorer, and a lot more disillusioned, ex market folk have actually learned and assimilated the lessons that the market smacked them over the head with.
This is, in fairness to the regulators, extremely difficult to ascertain.
To be continued…
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Why It Sucks To Be A Regulator Right Now Part 2
Furthermore, there are serious implications to simply banning people from accessing opportunities to trade/speculate/invest in markets, and that is, they never get to learn!
Because they never get to learn, they cannot acquire the skills needed to let their money work for them, which is the idea that the establishment so fervently sells to the masses.
This virtually guarantees that retail will lose their shirts in markets.
Think of the overly paranoid parent that wraps their kids in a germ free home environment. The kid’s immune system never has to fight, never learns, and thus never adapts. The kid steps out of the house… and bad things happen.
Same thing with people in markets; the best way to learn is to lose money. It is after all, a capitalistic society, and what is capitalism without the taking of risk?
Additionally, by locking retail out of risk taking, regulators are also locking them out of earning decent returns. Locking retail out on an arbitrary measure like net worth does not do them any favors because they never have the chance to access decent opportunities.
Risk and return, are at the end of the day, two sides of the same coin.
On a systemic level, limiting retail to only certain parts of risk taking in capital markets means that retail wealth does not have as good an opportunity to grow.
This is a precursor to growing inequality as most retail folk do not earn enough in wages to be able to grow wealthy, much less to fund their own small business as a way to become wealthier.
In this sense, limiting retail access also means limiting their ability to better their social and economic conditions (from a monetary standpoint). But, what is a capitalistic society where less wealthy folk are prevented from becoming more wealthy on the basis that they are not already wealthy?
It’s a powder keg, that’s what.
Now stand in the shoes of regulators for a moment. On one hand you have a policy of disallowing retail from participating fully in capital markets, which is at best, poorly executed.
On the other, a raging retail mob egged on by factors entirely out of your control.
When the BubbleMania ends badly, because it always does, there will likely be a good chunk of retail investors (yes, those your policies were trying to protect) turning on you and accusing you of not protecting them more.
Also, the entirety of Capitol Hill will be making a sport of throwing you under the bus even though some of those same politicians fought for retail to continue trading the BubbleMania in the first place.
Oh irony of ironies, what can one do but weep?
It truly is a bad time to be a regulator.
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Why It Sucks To Be A Retail Broker Now Part 1
How dare they prevent us from making more money! How dare they help out the hedge funds whom we are squeezing to death!? The Reddit inspired crowd has been raging that retail brokers are against their clients, the little guys, that they only look out for the interests of Wall Street. But what if neither accusation is true, and retail brokers are really only looking out for themselves?
The backdrop to this scenario is of course retail brokerages imposing trading restrictions on Gamestop and other heavily shorted names at the height of short squeeze insanity 2021. The natural response of Redditors was righteous fury, lots of internet bullets being fired, and even a class action lawsuit against Robinhood, a retail broker who is surely regretting their choice of name.
However, a better understanding of the pressures caused by the stampeding of retail investors into the same stocks will shed light on the actions of retail brokers.
First and foremost is the fact that, as the short squeeze exploded in intensity, retail brokers had to race to keep up with increasing margin requirements imposed on them by clearing houses. Margin requirements exist to protect the clearinghouse from a counterparty being unable to fulfil their end of a trade, in this case retail brokers having enough capital to pay for the massive amount of stocks their clients were purchasing.
Simply put, the more people piled into the same stocks, the more margin requirements had to be raised because ALL retail brokers were facing increasingly concentrated risk exposures in the same few stocks. This meant that should prices make a sharp move lower, thereby reducing the value of client accounts, ALL retail brokers would be on the hook for the difference. On the hook to whom? The clearing house.
If even a handful of retail brokers found themselves in such a situation and were unable to fork out the difference to the clearing house, the broker would be, well, broke. What’s worse, given the size of exposures in these stocks (and their related derivative markets), any retail broker going belly up would almost certainly have systemic consequences. That is, the whole system could have blown up in a massive chain reaction of defaults, fear, and hoarding of capital.
Ultimately, margin requirements are in place to ensure the core of the financial system can function smoothly without blowing up, and are a regulatory reality. Retail brokers must comply as a matter of law. Not a choice, this.
At the end of the day, the best way retail brokers had to relieve some of the pressure was to impose trading restrictions on the Reddit horde, which in turn bought them some time to bolster their own balance sheets with capital. Hence Robinhood scrambling to raise massive amounts of cash in a matter of days.
Therefore, from a financial perspective, nothing nefarious happened; just retail brokers fighting for their own survival in the face of capital calls that were growing too large too quickly.
But think of it from the standpoint of retail investors. No one likes being told that they can’t do something. It’s worse when what they are being told they cannot do is make money; and infinitely worse when FOMO is everywhere and it seems like everyone else can make money but them. Adding insult to injury is the fact that, in this whole saga, retail investors are the clients.
Given all this, can anyone really blame retail investors for feeling a burning sense of injustice, even though it really isn’t their brokers’ fault?
To be continued…
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