The end of a free market? | GameStop controversy

This week drew regulatory attention as retail investors found themselves shut out of their trading platforms after the buying frenzy for GameStop and other companies such as AMC Entertainment, Koss Corp and BlackBerry. 

The public is outraged that we cannot be allowed to manage our own risk, whereas hedge funds are allowed to continue as normal. Not only can they continue actively trading whatever stocks they like, they are taking advantage of retail investors being blocked from participating in markets. Trading platforms are protecting corporate interests while compromising the ordinary people. Retail investors know there are risks involved but rules of the free market should allow each individual to make that choice. 

What is happening feels like market manipulation, but is legally justified and legitimate. Many retail investors have been forced to lose a lot of money after trading was blocked for headline companies such as GameStop and AMC Entertainment. By “protecting retail investors from high risk”, many of us have lost out, majorly. 

So what is a free market?

Institutional investors support a free market when it suits them and then turn a blind eye when regulations are put in place! In economic theory, a free market describes a system where the price of goods and services is determined by consumers on the open market. In this system supply and demand create an equilibrium that self-regulates and is devoid of any government forces. The idea is to allow the system to maintain itself without the need of a governing body. In this type of market there is no need for tariffs to restrict trade or other economic tools as economic forces can themselves as a control. 

Photo by Josie Stephens on Pexels.com

Why has trading been restricted?

Most brokerages have halted buying in stocks that have had major rallies this week, including GameStop and AMC Entertainment. Retail investors are left outraged as they have no opportunity to participate in these highly lucrative markets.

Shares in GameStop dropped on average 55% after blocks to buying were put in place. On Thursday, large US broker Robinhood halted buying shares of the video game retailer GameStop, cinema chain AMC and tech pioneer BlackBerry, causing a huge drop in price. GameStop was down 44% and AMC closed at a huge 57% loss.

Large hedge funds had put billions on GameStop to fall. Yet when the power of Reddit encouraged a buying frenzy that pushed share prices to over 700% in just one week, these hedge funds were losing out. 

Hedge Funds who attempted shorting GameStop thought they were guaranteed profit by betting the out-of-date gaming company would continue to fail. However, they didn’t account for the power of the people who pushed the price in the opposite direction. A lot of investors were sceptical how long this frenzy could last, but with the story gaining traction across social media the stock has skyrocketed and brought some other dying companies along for the ride. 

Amateur investors who follow the Wall Street Bets subreddit have been encouraging buying GameStop shares to push up the price. Here, common retail investors are acting together as market makers. By pushing up prices this steeply, short sellers (ie Hedge Funds) incur huge losses driving them to buy back the shares they have borrowed from other investors to prevent even greater losses. This process is known as covering. Although this saves Hedge Funds, it encourages prices to rise higher as it adds to the demand. 

So why would brokers want to manipulate markets?

Essentially they want to cover their own backs. Brokers rely on large hedge funds to supply markets with shares. As hedge funds have so much capital they can tie up a large proportion of a certain stock if they choose, which is how they can influence markets – through controlling supply. 

Also, free brokers like Robinhood and Trading212 that advocate accessible trading don’t make money off transaction fees like some brokers. Their main income is by selling data that is gathered from retail traders to big Hedge Funds. Therefore , it is in their best interests to support Hedge Funds. 

By banning buying shares of GameStop and others, these free brokerage platforms are then only allowing selling. This reduces buying pressure and then allows the price to fall as retail traders can only supply stock and no longer demand it. Overall by reducing the price, Hedge Funds don’t lose so much on their short position and brokers benefit by supporting the survival of hedge funds that might’ve otherwise gone under. 

Threatened Legal Action

There are many people campaigning for  legal action to be taken against brokerages for market manipulation – by restricting sales of particular shares. 

Founder of Robinhood (the biggest US brokerage) publicly stated they had based their decision to limit shares based on regulatory requirements. 

“We made a tough decision today to temporarily limit buying for certain securities. As a brokerage firm, we have many financial requirements, including SEC net capital obligations and clearinghouse deposits.”

It is not just anonymous investors on Reddit who have commented on this debacle. Dave Portnoy, a high-profile amateur trader has attacked Robinhood, a platform that advocates for more accessibility on Wall Street. He tweeted

“‘Democratizing finance for all’ except when we manipulate the market, cause too many ordinary people are getting rich,” .

Analyst Neil Wilson said :

“what is so unusual is the peculiar vigilante morality of the traders pumping the stock. They seem hell-bent on taking on Wall Street, they seem to hate hedge funds and threads are peppered with insults about ‘boomer’ money.It’s a generational fight, redistributive and all about robbing the rich to give to the millennial ‘poor’.”

The public is outraged that we cannot be allowed to manage our own risk as brokers block buying certain stocks. Meanwhile Hedge Funds take this opportunity to their advantage, overpowering the market making moves of retail investors. This situation is rare but brings up some big questions about how the trading system works. If you aren’t ready to bet your money, download BullBear.

Published by bullbear.io

Optimising trading success through competition and guidance.

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