Reddit day traders are taking on hedge fund giants and winning, and it’s a sign of a new era for markets

WallStreetBets
  • The 4 million-strong WallStreetBets forum on Reddit has officially disrupted Wall Street.
  • They did it by piling into heavily shorted stocks, sparking short-squeezes at the expense of Wall Street hedge funds and large institutional investors.
  • “They are proving to be quite capable of mounting some successful ‘value capture’ against Wall Street institutional investors,” Fundstrat’s Tom Lee said.
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Wall Street hedge funds are scrambling, and it’s all because of a online investing forum that has more than 4 million members who self-describe themselves as “degenerates.”

Reddit’s WallStreetBets forum has surged in popularity after retail investors within the group successfully staged a gravity-defying short-squeeze in GameStop at the expense of hedge funds that were betting the physical video-game retailer was on its last legs. 

A short-squeeze occurs when investors who are betting against the stock are forced to close out their position by buying the stock, further adding fuel to the fire.

As of Thursday morning, GameStop had a year-to-date gain of more than 2,400%. The rally in GameStop crushed Melvin Capital, a roughly $12 billion hedge fund that has suffered a more than 30% decline due to its short position in GameStop.

The hedge fund received an emergency $2.8 billion investment from Steve Cohen’s Point72 and Ken Griffin’s Citadel amid the record surge in GameStop.

Read more: As Redditors flood the stock market, UBS breaks down 6 options strategies investors can use right now to protect their portfolios

Citron’s Andrew Left, a famed short-seller, also felt the heat from Reddit investors after he called for the stock to fall 50% last week. Left ultimately closed out his short in GameStop for a loss, as did Melvin Capital.

Maplelane Capital is another New York-based hedge fund that saw declines of about 30% due to its short position in GameStop, according to a report from The Wall Street Journal.

The developments are remarkable when you consider that retail investors on Reddit likely lack the sophisticated data feeds that multi-billion-dollar hedge funds rely on.

But after spending a few hours on the forum, billionaire investor Chamath Palihapitiya concluded that the Reddit traders can do the same fundamental analysis as hedge funds, if not better. Palihapitiya ultimately followed the retail investors into GameStop, and won big.

Now, Reddit traders are trying to replicate the success of GameStop and are targeting other stocks that are highly shorted by professional investors. And they’re succeeding.

Stocks like AMC Entertainment, Bed Bath & Beyond, and Virgin Galactic have soared this week as Reddit investors piled into the names via both stocks and deep out of the money call options, creating unprecedented demand for the shares.

Read more: A chief investment strategist breaks down how the GameStop saga could upend decades-long practices on Wall Street – and shares her 4-part advice for navigating the frenzied trading environment

“They [retail investors] are proving to be quite capable of mounting some successful ‘value capture’ against Wall Street institutional investors,” Fundstrat’s Tom Lee said in a note on Monday, adding that “large size does not always win.”

But the influence of WallStreetBets on stock moves could wane in the future as systematic funds “adjust” their models to incorporate this new source of volatility, Lee said.

And it’s not only quant funds that could put a dent in the influence of 4 million Reddit traders, it’s also trading platforms.

On Thursday, Robinhood restricted buy trades in a handful of stocks that have seen epic short squeezes and have been targeted by the Reddit group, including GameStop, AMC Entertainment, and Nokia, among others.

Now the question is, according to Lee: “Will their strategies endure?” 

Read more: Morgan Stanley handpicks 18 US stocks to buy for the best business models that deliver market-beating returns for years to come

Read the original article on Business Insider