Unless you have been living under a rock, it is no question been a “Wow” kinda New Year — from Pandemics to Insurrections and everything in-between. I feel like writing this particular piece because there seems to be controversy around how the markets should operate.
How do brokerages act with the stock exchange?
I am not an economist, but it is clear that a brokerage is an intermediary or middle man of the sorts for “Non-Hedge Fund” and “Non-Big Bank” investors to have the ability to participate in the open market. That means TD Ameritrade, Charles Schwab, and yes, Robinhood all have agreements that allow them to be the intermediaries.
What makes a stock valuable?
In general, it has to do with supply (# of shares available in the market) and demand (the amount of buying or selling done within the market). While there is probably disagreement within philosophy, politics, and B-Schools on how that value is defined, I think all disciplines agree that there is a certain level of abstraction. Additionally, for the most part, we can agree that there differing corporate valuations and reflective market prices attached. For example, both Twitter and Alphabet create value. Alphabet offers more value; their stock is more valuable than Twitter’s stock.
How value is defined and attributed is more abstract. Is value emotional, qualitative, quantitative? Is the value implemented relatively across the market? The purpose of this article is to address the logistics around GME (Game Stop’s Stock), but for this particular section, it is a good example. I, like many others, have a sentimental attachment to Game Stop. That is valuable; however, if I am buying a console, I will buy a Digital One — this detracts from the value. Of course, this effect is the outcome of innovation and disruption in the market that makes the “Job” of getting consumers Video Games easier than ever, which reduces market barriers, and allows competition to rise.
What is a Short/Long?
A “short” is when an individual or entity takes a position or “bet” that a stock will go down. If it does go down, how much it goes down affects the net profit. Alternatively, if it goes up, how much it goes up implies the net loss. A “long” works the same way but is the inverse of a “short.”
What is a Short Squeeze?
A “short squeeze” is when another entity tries to interfere with the original “short” position(s). Billions, a Showtime Television show, showcases the dramatization and militia-like tactics of events like these.
What happened with GME?
Wallstreetbets, a Reddit thread, saw the short position hedge funds took on GME and used its influence and crowdsourced user base to “short squeeze” the hedge funds. It got out of hand.
Was what happened okay?
Well, YES and NO.
Yes, in an open market, market participants should be allowed to participate. Yes, it is okay for regular people to challenge the pros.
No, it is not okay to obliterate market participants. The discrepancy between the value of GME and where the stock rose to is not how markets should operate. It is OK to stop a short; it is OK to go for the proverbial “field goal” after the “touchdown,” however it is NOT OK to obliterate and breach all fair play guidelines.
Why are people so divided and mad about it?
Well, there are two things in play.
A. The general public doesn’t support Big Money, and they think the rules got changed in Big Money’s favor.
B. Robinhood had a significant branding issue. Their brand is in their name, Robinhood — the idea of “Taking From the Rich and Giving to the Poor.” They also wanted to create an easy way for the everyday person to interact with the market. All fine and good, however, there are two problems with this.
FIRST, no matter their intentions, Robinhood is reliant on their ability to participate as an intermediary. This reliance involves compliance with the SEC, Banks, and other significant players. Like Chipotle, they drove their brand with their internal intention, not accounting for their reliance on other players. In Chipotle’s case, they advertised unmatch quality with local suppliers, cornering themselves into unmaintainable standards. In contrast, Taco Bell has had food quality problems, but no one cares because they know they are taking a risk going to Taco Bell.
SECOND, Robinhood may have opened the market too broadly. Pre-Robinhood, nothing was stopping an individual from opening a brokerage account (which is what you create when you sign up for Robinhood). The process was just more complicated than downloading an app and clicking a button. That is not a negative, aside from the reality that financial literacy is not widespread throughout the public, and Robinhood did not explicitly make clear the rules and risks of engagement.
Who is at fault, and how do we fix it?
I would argue that no one single group or entity is directly responsible for what happened with GME; however, we can make changes to prevent this in the future. Implementing a stock freeze on abnormalities, followed by human inspection before unfreezing, could solve this. For example, with GME, if there were a mechanism in the (computerized) stock exchange to freeze the stock at $100 (the apex of the exponential growth that occurred), every participating investor would have a moment to cool down, and the SEC could have formulated a proper plan. This mechanism would not have prevented the “short squeeze,” at $100, the “short squeeze” was already successful. This mechanism would have provided time to the general public to fully understand the nature of why GME was rising. The third benefit is found within a hypothetical: let’s say, that Pfizer cures every type of cancer, GME type growth would occur. In this situation, the mechanism would put a temporary freeze, the human inspection could happen, and the stock could un-freeze. There might be a slight advantage to some investors on the reopening (due to lower latency, allowing faster reaction time). However, people would hypothetically continue to buy the stock, and the mechanism will likely not have adversely affected Pfizer’s stock growth — all because the stock growth would be based on real value.
Ending Notes and Qualifiers:
a) in “what makes a stock valuable”, just because I might not buy a disc version console, doesn’t mean that other people might not. The presence of the commentary is to establish that their is a divide in preference and that divide is caused by the growing number of market solutions.
b) in “who is at fault, and how do we fix it?”, $100 is an arbitrary number that happens to fall around the apex of exponential growth within the specific case of GME. Exponential growth can be measured by the “rate of change”, which is what the suggested mechanism should be based on.
c) in “why are people so divided and mad about it?”, my comments on Taco Bell are strictly based on my own opinion, however may be shared by others.
d) in “who is at fault, and how do we fix it?”, a reader might assume that a freeze on trading is what happened and the point of the article is mute. The distinction between what happened (a halt on trading) and what this article suggests is: with a mechanism, it is applied to the entire market and triggers via a conditional computerized, reduced-biast, processes; then undergoes human review. What happened with GME was solely moderated by human review.
c) This is an opinion article, the solution provided may not be the best one. However, there is no single right answer, there is no solution that can make everyone happy. This does not mean we should not want to create a better solution.
d) I did not invest or short or take any positions. Lots of people made money and lost money (big money and the general public). It is simply logical to assume that there should be mechanisms in place to protect all participants while minimizing interference in free-market processess.
