What does it mean for a market to be manipulated?
I know there are legal answers to this question, but that’s not really what I’m interested in. I am more interested in where and how we, as the blood-thirsty capitalist society that we are, draw the line between the market being the market and the market being manipulated.
There are a few ways to think about the answer to this question. There is the free market libertarian answer, which says that whatever the market is doing must be right. There is the fundamentals, rules-driven approach, which says the market will always (eventually) revert back to reasonable multiples of the metrics that textbooks and professors have deemed to matter. And then there is the democratic approach, which says the wisdom of the crowd ought to prevail. I am not sure that we should call it wisdom, but this week the crowd certainly prevailed.
The enormous rally in GameStop equity (and the corresponding pain felt by certain hedge funds which were short the stock) represented a coup de grace for retail investors in a battle that has been waging for years.
Several phenomena have been working synergistically to bring retail traders en masse into the markets. There have been the trends that have been playing out for years: increased accessibility, thanks to entrants like Robinhood; the rise of influencer culture, in which one or a few individuals can mobilize their digital followings; ongoing disillusionment with the establishment, a theme that dates back at least to the 2008 crisis; and the internet-driven narrowing of the gap between expert and amateur that has occurred across all fields over the last decades.
Then there have been the catalysts specific to this past year. 2020 saw sports betting close down and casinos shutter. It saw a single-day stock market drawdown that forced many to question what they were doing with their 401(k)s, if not their lives, followed by an incredible rally in the face of dismal economic realities. It was the year of being forced indoors and onto screens. It is no wonder that last year smashed all records of new retail brokerage account openings.
The flood of retail investors and retail dollars has generated a new set of tensions. This came to a head this week in the coordinated buying of GameStop stock and call options by retail investors coordinated on the Reddit forum WallStreetBets.
The remarkable moves in the stock market on the back of this forum have produced two camps. There are those who say these retail traders are colluding to manipulate the market and force these stocks to territory in which they have no business being (see also: Tesla). Subscribers of this view seem to be mostly Wall Street natives and the surrounding media outlets.
Then there are those who say the markets were already manipulated, in particular by the hedge funds who had put on artificially large short positions to begin with and had not appropriately managed their risk. Those in this camp tend to ask: Why shouldn’t retail traders be allowed to do this?
Why shouldn’t they indeed? After all, if it was another hedge fund executing this trade and short squeezing the market, it would just be another day on Wall Street. That the adversary here is a sort of decentralized swarm of retail traders is what makes the phenomenon both remarkable and controversial. And it highlights a double standard.
The trading floor, as I once knew it, was not all that different from the WallStreetBets Discord chat. It was a place of stress, euphoria, arguments, cooperation, laughter, name-calling, insights, inappropriate remarks and banter. It also had the same clubby, in-group feel that online communities often develop. Those who worked there had nicknames, jargon and their own way of talking about things.
Think of the portrayal of trading desks in every bit of media you have ever consumed. The people pounding desks and putting their fists through screens; the bosses swinging baseball bats around; the rolled up sleeves and dilated pupils; the obscenities. When Yale-educated men in button-downs engage in these behaviors, they become the Masters of the Universe. Yet, when anonymous online avatars and energetic YouTube personalities do so they are cast as immature, basement-dwelling kids.
The double standard at play here extends beyond the conduct and deportment of these two groups. It also extends to their methods of engagement in the markets. When hedge fund managers get together and share insights and ideas, it is all in the name of moving towards a more efficient free market. Yet, when the online mob of retail traders comes to consensus about which stock is worth buying, they are considered by some to be artificially pumping the name and manipulating the market.
So, are they manipulating the market? Again, the situations of this past week highlight just how strange this question has become. In some ways, one cannot participate in the market without manipulating it. The very act of buying and selling is, in some way, manipulation. There are of course more extreme forms of it: painting the tape, spoofing, pumping and dumping.
Generally, but not always, these involve some level of privileged access – either to the market at hand or to the infrastructure of the market. This is part of what makes the accusations of retail manipulating the market comical. These traders came to the fight armed only with the Reddit forum and their Robinhood accounts.
This is the problem with thinking that whatever the market is doing must be right. Market participants are not equally equipped as they walk into the market to do battle. Markets are not actually free, meaning they are distorted away from theoretically optimal pricing. The realities that certain players have access to more capital, more leverage and more financial instruments to express their views render the markets manipulated by default.
It is worth noting that the GameStop phenomenon would not have been successful for these retail traders without the power of options and leverage. It is often said that Robinhood is democratizing trading. It is also democratizing access to these powerful market tools, leveling the playing field in a way that hadn’t been done before.
This brings us to another double standard. Much has been made of the dangers Robinhood poses for its retail customers. People should not be allowed to trade with leverage, the wisdom goes. They do not know what they are doing and they will get hurt. In this situation, however, it appears that it was a certain institutional hedge fund that did not know what it was doing and got hurt. Of course, for institutions the world provides crash pads and government-funded bailouts. For retail, this is not a possibility. And so the only way forward we offer is the old wisdom: Don’t invest what you can’t afford to lose. Just put your money in an index fund. Stay out of the markets if you do not understand them.
But the rules are changing. Who doesn’t understand the markets now?