The Irish Times view on stock market volatility: the traders who shook Wall Street

It is surely only a matter of time before GameStop, the US video games retailer that has become the subject of a market frenzy, becomes a verb. In recent weeks, the loss-making company’s market value soared as much as 2,300 per cent to a highly implausible $34 billion (€28.2 billion) as a swarm of small-time investors took on Wall Street hedge funds who were betting against the stock of a retailer whose sales decline over the past decade, as gamers moved online, was accelerated by Covid-19.

The hedge funds’ strategy was to “short sell” the stock. It involves borrowing shares from investors in a company and selling them on the market. The hope is that the shares fall before the fund buys them back on the market, returns them to the original shareholder and pockets most of the difference as profit. Short-selling has a role in a healthy market. It provides an alternative view of a company and its prospects and helps establish a fair value. Many short-sellers put more research into companies than traditional investment firms that merely track indices like the Iseq, FTSE 100 or S&P 500. However, if the trade goes against the short-seller and the stock soars, the fund is forced to buy stock to limit its losses.

The last few weeks has seen a throng of amateur investors, who use discussion website Reddit’s WallStreetBets chatroom to swap tips, pile into GameStop shares to force the price up and inflict losses on the hedge funds. They have surged in number since the onset of the pandemic, enticed by the stock market rally since last March, lockdown boredom and commission-free trading apps like Robinhood.

Many in the chatroom have galvanised around taking on the system and "democratising capitalism". Nobody really thinks Gamestop is worth anything like the value it scaled to. But the Reddit crowd has shaken Wall Street, with the Melvin Capital hedge fund, nursing large GameStop losses, forced to secure a $2.75 billion bailout from some rivals. Other heavily "shorted" stocks such as Blackberry, Nokia, and cinema chain AMC Entertainment have also surged in recent weeks.

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GameStop shares have turned exceptionally volatile since late last week, a signal, if one were needed, that they are out of kilter with their fair value. Many small investors that piled into the stock in recent times will be burned. US regulators will need to investigate the trading activities of some of the loudest voices in the Reddit chatroom to see if they manipulated others into buying a stock before dumping it themselves.

Meanwhile, the focus must turn to the growing role of hedge funds in global finance and their risky reliance on debt in investing. A collapse of a fund – averted this time – would have far-reaching consequences. Increased regulation is inevitable. GameStop may become a verb. But it is not yet clear what it will come to mean.