Stock markets are notoriously volatile and can be prone to rise and fall sharply based on nothing more than rumours. However, in the past few weeks we have witnessed a new phenomenon in the form of stock market manipulation driven by people on social media forums which could have significant implications in the future.
What Happened in the Gamestop Phenomenon?
Users of the internet forum Reddit identified that hedge funds were engaged in the practice of ‘shorting’ the stock of US-based retailer GameStop, and decided to take on the hedge funds in a David and Goliath style battle.
Shorting is a practice where hedge funds borrow shares of a particular company and sell them, with a promise that they will buy the shares back at a later date. The hedge funds hope that in the intervening period, the value of the shares will fall, so, when they come to buy them back they will make a profit. To give a very simple example, the hedge fund could sell a share for £10 and then buy it back later when the value is £7, in which case they make a £3 profit. Shorting, in effect, is a bet that the value of the company in question will fall.
Having its shares shorted by hedge funds tends to be bad news for the targeted company. It is usually a sign that all is not well, and it can spook other investors and lead them to sell their shares which will typically drive the share price down. Reddit users saw that GameStop was being targeted and decided to take action against the hedge funds.
Reddit users and other retail investors started to purchase shares in GameStop and, as the activity gained momentum, more and more people started to buy. This caused a huge spike in demand and resulted in GameStop’s share price rising in value by over 1,500% in a matter of days.
This was bad news for the hedge funds who found themselves staring down huge losses as they were obliged to buy back the shares they had sold in GameStop which, rather than decrease in value, had instead soared. The price of GameStop shares has since plummeted but not before losses for hedge funds ended up running into the billions.
Could This Happen Again?
Rushes on stocks happen often, but what happened with GameStop was an unprecedented phenomenon that has opened up questions about how vulnerable markets are to manipulation of that scale.
Hedge funds and professional investors are used to the tumultuous nature of the stock market. However, when inexperienced retail investors become involved, they can get their fingers badly burnt – there have been stories of GameStop investors losing tens of thousands of their own savings when the price started to fall.
Many investors in the GameStop frenzy were heavily encouraged by posts on social media sites and questions have been raised about whether stricter regulation needs to be introduced to deal with potential influencing of investments. One example is Tesla founder Elon Musk who tweeted at the time a link to the Reddit forum which could have led to more people getting involved. In another example, Tesla also announced in recent days that it has invested over $1 billion in crypto currency Bitcoin which has caused a surge in its price.
Impact on Regulatory Bodies
The GameStop shares were listed in the US, but that is not to say that a similar thing could not occur on the UK stock market.
In the UK, the Market Abuse Regulations are designed to police investments and prohibit behaviour which gives false or misleading signals about the supply, demand or price of shares. Clearly, the GameStop case was a co-ordinated effort to increase the share price, and could be viewed as a reaction to a the controversial practice of shorting. However, regulators in the UK have confirmed that they were monitoring activity for potential lawbreaking. It is unclear whether anyone was deceived by false or misleading signals and regulators would have to consider whether individual consumers really are able to exert such significant influence as to be guilty of market abuse?
Regardless, the Financial Conduct Authority will no doubt be keeping a close eye on any future activities as we may see a growing trend – the GameStop phenomenon has demonstrated to regulators the power of social media and they may be forced to take action to protect consumers and retail investors (in some cases from themselves) in the future.