Many in the business call this “pump and dump.” Depending on how it is done, it is illegal. The electronic marketplaces of today are certainly “efficient.” They are more efficient these days than they used to be. But they are still prone to the same whims and excesses that old human-traded markets were. Markets are rational, but sometimes, there are moments of irrationality. We see it from time to time, and behavioral economists love to parse the data on them after they become rational again.
That’s the hard thing. What’s rational and what’s not? It is purely a subjective and not objective concept. Maybe I see something in the stock you don’t see and so it is perfectly rational for me to bid the price up even though the rest of the world doesn’t understand it. That’s called creating an edge for yourself and assuming risk that others are unwilling to assume because they don’t see the same world you do. I don’t think what happened this past week in certain stocks can be categorized as illegal.
Over the past few years, the “meme stock” craze might be the nuttiest and most humorous thing I have seen. Read the Reddit message boards. They are funny. “I like the stock.” They call them “stonks.” The day traders love to poke fun at the suits on Wall Street.
Meme stocks are stocks that aren’t valued very highly for some reason or another. Usually, their average daily trading volume is pretty low. They tend to have a lot of what’s called “short interest.” This is where funds borrow the stock and sell it. They are looking for the stock to go down in price, not up. Meme stocks also usually have a “low float.” This means there are not a lot of shares out in the marketplace to be bought or sold. Daily volume is usually pretty low. No one pays close attention to them like they would a stock in the Dow Jones. Meme stocks are also usually boutique businesses. Examples of some meme stocks are AMC Movie Theaters and the very popular GameStop. Meme stocks are not for the faint of heart. They can be extremely volatile, and they move on whims. There is no logic behind any of the movement.
Here is some background on meme stocks. In 2020, a Reddit board that goes by r/wallstreetbets put a hedge fund out of business when GameStop rallied from the depths of $1.19 per share to a high of $81.07 per share. The move happened between August 2020 and January 2021. The hedge fund was short and got caught with its pants down. The pinstripes on Wall Street were outraged. Congressional hearings were held for some reason. Online brokers such as Robinhood shut down trading in the meme stocks. The gremlins on the Reddit threads rejoiced. They had “diamond hands.” It’s as if the nerds won one. The leader of the pack goes by the handle “Roaring Kitty.” At one point, his trade was worth $48 million, but no one knows how much he pocketed from the move. Roaring Kitty went into hibernation.
GameStop shares closed up 74.4 percent on May 13 and closed up another 60.1 percent on May 14. On May 15, the stock started to sell off. The stock’s slide continued on May 16 and suffered its worst two-day stretch since 2021 when it fell by 43.2 percent. Who knows what will happen on May 17? Flip a coin. To me, it looks like a short squeeze. The shorts that got squeezed are out. That’s why the stock is selling off.
Often, a rising stock market or falling stock market will move stocks. If we look at the S&P500, it was down slightly on May 13, up slightly on May 14, up sharply on May 15, and down on May 16. The only day GameStop defied the S&P500 was on May 13.
Why do moves like this happen?
It happens because people follow the herd. They don’t think for themselves, and they are not objective. They are looking for the easy way. It is not any different than what I witnessed in trading pits back on the old human trading floor. The thing today is moves can scale quickly. Roaring Kitty has 1.2 million followers on X. He has people who follow and report on him all over Reddit and other social media outlets. Electronic trading happens faster than you can blink your eye. It’s also easier to accumulate positions and dump them faster on electronic platforms than on the old human platforms. On the human ones, everyone could see the trade happen. Not so with electronic trades. Additionally, because it’s in an SEC-regulated market, most of the trading happens off exchange in dark pools set up by brokers and institutions. It’s easier to mask the building or unloading of big positions. Ask Warren Buffett. He doesn’t announce his positions until after he has acquired or dumped them.
Following the herd should be nothing new to anyone who reads this publication. How many people do you know said to “do this” or “do that” during COVID-19 and people followed? Is it any different than a bunch of electronic traders piling into a little traded stock with a very low float and low daily volume pumping up the price because they are following one person into the trade? They don’t even actually know if he is in the trade or not. They just assume he is and are acting on it.
Does anything need to be done about it? No. Markets will take care of it. Free market capitalism can be really messy at times, but at the end of the day, it is always better than centralized bureaucrats at allocating capital and making decisions.
