Tuesday, January 26, 2021

WallStreetBets Reddit & Robinhood: a herd distorting the markets

Even a broken herd may be right about once a decade

I have been aware of the insane Tesla and Bitcoin (and other cryptocurrencies) bubbles which show how (mostly) the Millennial generation makes the markets – or at least the price discovery – dysfunctional. But those are just the most extreme tips of an iceberg. This new culture of hyper-conformist obedient sheep that are tied to the social media has an effect on many other corners of the financial markets.

Well, sometimes the effect may be healthy and push the prices towards fairer values (but I believe that it is mostly a coincidence when it is so).

For some time, I have been aware of the Robinhood trading platform. I didn't pay much attention to it. It looked like another platform – why should it matter what you use to trade your stocks and options? You should register at robinhood.com and download the app there (Robinhood may be found in the app store). There are alternatives (such as Webull, also search) but it seems that "virtually everyone" who belongs to the sheep culture simply must use Robinhood.

OK, the choice of a platform doesn't really matter much. You may use the name Robinhood as a search query to look for the thing that is actually important – how these people (and they may be millions of young small investors) make their decisions. And only yesterday, I was made aware of the power of a discussion group affectionately called WSB which stands for WallStreetBets at Reddit. This is a sub-Reddit forum similar to the Bitcoin one and others. Note that you may sort the contributions from the "new", "hot", or "top" rated ones.

The visitors of that forum are a giant herd – perhaps millions – of mostly small investors who run in the same direction, according to the instructions. They deliberately pump a stock they pick. In the past, they pumped Tesla and they are a major driving force of this insane bubble – Tesla is overvalued by a factor of one thousand or so right now.

Read this short web page to understand something about the culture of these people. They dislike shortsellers because they represent a negative thinking, the will to harm someone else and cherry-pick the bad things.

Well, I have some understanding for the sentiments. Shortsellers may be not just passive "betters" but producers of distorted negative news that actively hurt someone else. I particularly hate the people who short the whole indices i.e. the whole economy – they are jerks who are really rooting for the misery of everyone (or misery of the most).

But shortsellers still play a very important role in the financial markets. They make it much more efficient to find and deflate bubbles, stocks that became crazily overvalued for some reasons but that cannot return down because the current owners are fanatics who "hodl". Tesla is a great example. Shortsellers create the extra supply of the stocks even when the bullish fanatics are unable to do so. In healthy markets, the shortsellers would win soon and the empty, uninnovative, mediocre, and fake snake oil salesman Elon Musk would have never become a multibillionaire let alone one of the richest people on Earth. Too bad, these sheep were capable of beating the healthy markets and created this insane bubble around the worthless carmaking company.

There is one crisp way to formulate what's primarily wrong with these "warriors against shortsellers". They don't understand that not all shortsellers are created equal. Every corporate stock has a fair price and the shortsellers who start their position when the current price is (much) higher than the fair price are right and desirable (and they deserve to make a profit); and those who start the short position when the stock is already undervalued are wrong and evil. The boundary between them is hard to determine, that's what all the activity in the market should help to figure out (the process is called the price discovery). To fight against all shortsellers is just wrong for this reason – it fails to discriminate. Leftists always fail to discriminate (everyone is equal!) so these anti-shortseller activists are just another branch of the leftist activists.

But their impact is not always this bad and maybe it will be getting better – and these activists will grow into a healthy, increasingly competent if not sophisticated, community of traders. If you follow the news or own one of the stocks, you must have noticed that in recent days, there has been a massive growth of the prices of companies that were considered hot some 15 years ago (but whose capitalization has dropped to units or dozens of billions of dollars) such as GameStop (GME), Bed Bath And Beyond (BBBY), BlackBerry (BB), and, indeed, Nokia (NOK).

The latter is how I learned about the WSB phenomenon (my position should turn from red to black numbers in hours again): the good news (some new 5G mobile data gear contracts; an interesting joint venture with Google Cloud; mobile data on the Moon, literally; some new 5G speed records; artificial intelligence-powered management of the networks achieved with China Mobile; 4G/5G network slicing which first succeeded in Riyadh, and more; not to mention some buying recommendation by SEB who predicted the return of the dividends etc.) were simply not enough to explain the 20% growth of the stock in a day.

And I've found the Reddit readers, Robinhood users who indeed invested to Nokia yesterday because they have read something on Reddit. I am almost certain that a majority of the stock price growth of the companies (GME, BB, BBBY, NOK) were powered by the WSB Reddit users. Some hedge funds were completely liquidated; short positions were forcedly shut down and the resulting short squeeze generated additional upward dynamics in the stock price. Many of the Robinhood traders buy call options (for significantly higher future prices) that may massively appreciate in price but many of these Reddit users generally buy stocks, too.

I don't have any data proving which of the WSB posts was most important for the pumping of the prices of the companies above. The most relevant ones could have been short and stupid posts like "Nokia will fly" or "not fudging selling $NOK" or "$184,000 Nokia to Valhalla and beyond" (real titles!) and I actually think it is the case. But some of the posts were amateur-generated, but in my opinion rather high quality posts such as
Nokia $NOK Debunking common myths. And a look at recent news
A Closer Glance at Nokia
The Real Case For Nokia
and more. You are invited to do your own research. There is some degree of childish science-fiction in many of these posts ($2 trillion mobile data economy on the Moon etc., sure) but there is also some real information and understanding. With a greater amount of such competing posts about companies, the community over there may evolve into a rather intelligent bunch of investors (although i still find too little quantitative information in those posts [about earnings per share etc., you know] so they're more about feelings which can't directly translate to an accurate fair price; maybe the Reddit users will learn numbers in a few years). I chose Nokia because that's what I follow (and trust). It's possible that their texts on the other companies are comparably justified (or not).

My namesake The Motley Fool claims that Nokia jumped 20% on Monday because of some SEB analysts' report. Please, give me a break. Another recommendation by a random analyst never creates this 20% dynamics. The Motley Fool clearly lives in an old world – they have never heard of Reddit.

I think that so far, the net influence of these Reddit investment herds on the financial markets is harmful. But it may change. What is already clear is that they have become a formidable force (and one whose strength is likely to grow in the foreseeable future as this generation and its wealth keeps on growing), a bunch of activists who may influence your own investments and/or liquidate your hedge fund if you short a stock that these sheep feel sensitive about. You may better check what is the mood of the WSB Reddit folks about the companies that are important in your portfolio. On the other hand, I sincerely hope that you won't become another sheep that just mindlessly copies the orders from such a herd. It would be much cooler if you were financially literate and you succeeded in teaching something to these sheep!

Disclaimer: While this Reddit investment methodology is fundamentally wrong and investors should really think with their own heads, otherwise the system doesn't work, I will forgive these "collectively thinking investors" if or when they inflate the Nokia stock price by an order of magnitude which would still be marginally fair given the clear growth potential and relevance of Nokia's technologies and rather advanced know-how.

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