Gonçalo Moutinho
Financial Markets
Gonçalo Moutinho
Financial Markets
António Tunico
Financial Markets
António Pedro Tunico
Financial Markets
The emergence of the Internet and online trading platforms during the 1990s and 2000s made it easier than ever before to buy and sell securities from the convenience of a personal device. The proliferation of brokerage accounts with low minimum balances and transaction fees has facilitated retail investors’ access to the stock market, breaking down many of the barriers that once impeded their ability to transact securities. Advances in technology also made information regarding the stock market significantly more widespread and easily accessible, enabling retail traders to stay updated with the latest market trends.
This democratization of financial markets has enabled individuals to exercise greater control over their investments, while making independent and informed investment decisions, without the need for a traditional broker or financial advisor. It changed the way retail trading is perceived, from buying and holding stocks for the long term or investing in index funds, as it was previously associated with, to more short-term, speculative trading strategies, that capitalize on market fluctuations.
The rise of social media and online forums in the last decade made it possible to exchange knowledge and coordinate investment activities in unprecedented ways. This new era of investor collaboration has created opportunities for retail investors to profit from high-risk, high-reward investments. Furthermore, due to the ease of trading securities on a personal level, this led to a more speculative approach to investing and has become a driver of market volatility, with individual investors exerting a considerable influence on stock prices.
As a result, the retail trading phenomenon became increasingly popular and has grown substantially since the beginning of this century, with more and more individuals investing in the stock market, especially younger generations, who have grown up with technology at their fingertips. The COVID-19 pandemic was, however, the main factor responsible for the acceleration of this trend.
As millions of people were confined to their homes, due to social isolation measures, many turned to online platforms for entertainment, social connection, and financial activities. Besides, with casinos closed and sports events canceled, the stock market became the perfect gambling platform. This led to an increase in online trading and investment, with retail investors seeking new opportunities to make money in the volatile and unpredictable economic environment. Additionally, the pandemic led to extended government stimulus and low-interest rates, creating excess liquidity in the market and an overall surge in stock prices.
Throughout the COVID-19 pandemic, countries like the US also witnessed social and civil unrest. Millennials, a generation that has more debt than any other, particularly in the form of student loans, were at the center of these societal upheavals. A willingness to challenge societal norms, combined with a backdrop of significant levels of personal debt, has therefore resulted in a shift in investor behavior and substantial risk-taking. This was further facilitated by low-cost, self-directed trading.
All the factors mentioned above paved the way for a new retail trading phenomenon: Meme Stock Buying.
Meme stock buying refers to the practice of many retail investors combining efforts to buy shares of a company to drive up its stock price. Collectively, their independent actions can initiate big moves in a company’s stock price.
Although this phenomenon started in early 2020, it culminated in the GameStop short squeeze of January 2021, which was primarily driven by retail investors who coordinated their efforts on social media, especially on Reddit.
It all started with r/wallstreetbets, a Reddit subreddit or forum¸ created in 2012. What was initially a small community of traders sharing ideas, strategies, and their independent research, evolved into high-risk and high-reward trading strategies, with a heavy focus on options trading.
With Reddit being a social media platform dominated by memes, this community soon morphed into a forum for meme-driven trading strategies, with its own very specific lingo and unique culture that attracted a growing number of retail investors.
By December 2020, the subreddit had amassed 3.5 million followers, thanks in part to the pandemic and the emergence of commission-free trading platforms, particularly Robinhood. With a user-friendly interface, zero commissions, and a mission to “democratize finance”, the broker quickly gained popularity among retail traders and became their preferred trading platform. The ease of use and accessibility of Robinhood allowed more people to participate in these strategies than ever before.
In early January 2021, the users on r/wallstreetbets started moving markets significantly, thus attracting attention from large media outlets and hedge funds. Some hedge funds publicly accused the users on r/wallstreetbets of artificially inflating stock prices and proceeded to short these stocks, with GameStop being the most prominent target.
GameStop was, at the time, a video game retailer in financial distress, as it was severely affected by the shift toward digital game sales and the COVID-19 pandemic. Amidst a series of continuous losses and a very bleak outlook,
some hedge funds believed that the company’s financial troubles would eventually lead to its bankruptcy, so it began to heavily sell short its stock.
Since the number of shares sold short exceeded the number of existing shares, r/wallstreetbets users saw an opportunity for a short squeeze. The discussion gained momentum as well-known investors, like Michael Burry and Ryan Cohen, announced large stakes in the company.
With fresh capital coming from the stimulus checks handed out by the US Government in the first days of 2021, retail traders bought large amounts of deep out-of-the-money (OTM) call options on GameStop, driving up the price exponentially and inflicting nearly $8 Billion in losses to short-sellers. This activity also extended to other stocks belonging to the heavily shorted category, such as AMC, Nokia, and Blackberry, which saw similar spikes both in trading volume and price.
As media coverage increased, the social movement gained even more steam, taking over social media discussions. On January 28, 2021, GameStop reached an intraday high of $483 per share, after opening at $4 in 2020. GameStop shareholders were now millions of retail traders spread across the globe.
However, the movement hit a roadblock when Robinhood, the platform used by most of these traders, removed the “buy” button, placing a buying restriction. With no ability to buy, the selling pressure was impossible to contain, and the price dropped substantially. Large demonstrations of outrage ensued with retail traders pointing toward market manipulation. Even some distinguished US Congress members joined the protests, calling for criminal investigations and congressional hearings. Although these hearings did take place, there were no convictions. Robinhood, however, was still heavily punished, as it faced large outflows and a drawdown in trading activity.
Eventually, the frenzy came to an end, with the stock price gradually falling, as the enthusiasm and public coverage eventually dried out.
This event transcended beyond just a short squeeze and turned into a social movement, with millions from all around the world, not just in the US, joining in.
It is important to note, however, that investors have both won and lost millions in the meme stock craze. GameStop, the company, emerged as a winner, increasing its market capitalization from around $2 billion in early January 2021 to over $10 billion by the end of the month, giving the company much-needed capital to help with its restructuring efforts. On the other hand, hedge funds that had bet against GameStop were caught in a short squeeze and lost billions of dollars. Robinhood also faced significant backlash from its users for halting buying in GameStop and other stocks. Finally, this frenzy exposed regulatory loopholes and weaknesses in the system, leading to calls for increased scrutiny and stricter regulations.
The long-term sustainability and impact of this trend on the broader financial system are still subject to debate and scrutiny.
After the Meme Stock Mania subsided, many experts predicted that retail trading activity would decline, with some warning that a prolonged bear market would prove to be the final dagger in the deacceleration of this phenomenon.
However, the reality has been quite different, as retail investors have continued to participate actively in the stock market. In fact, data from JP Morgan shows that retail investors accounted for up to a quarter of all stock trading in January 2023, surpassing the previous peak seen during the Meme Stock Mania.
Although smaller investors have registered net inflows greater than $1.5 Billion per day, a record, the type of purchases has changed, shifting dramatically from options to dividend-paying household names, like Coca-Cola and AT&T. These stats prove that retail traders can be quite resilient and adaptive, weathering challenging times like the ones we face in the present.
Daily Net Inflow by individuals
($mn, 21-day moving average)
Despite the numerous headwinds, the growth of retail trading is likely to persist, as the continuous push for digitization and a growing interest in financial markets further contribute to the expansion of this phenomenon.