Video: Jim Cramer says wallstreetbets, Reddit has altered market psychology

The meteoric rise in GameStop's stock, as traders congregating on Reddit and Discord take on short sellers and hedge funds, is hard to look away from. It's the closest thing Wall Street has to David vs. Goliath.

An army of smaller-pocketed, optimistic investors threw dollars and buy orders at the stock of GameStop — in direct opposition to a group of wealthy investors who are counting on the stock price to plunge.

What's happening: Shares of GameStop, a legacy company whose stores are often located in struggling malls, have soared dramatically over the past two sessions as day traders push the stock with growing fervor.

Investors have been betting that GameStop's stock will fall. They “shorted” the stock, essentially thinking shares would tank. But such bets have been disastrous recently.

Meanwhile, a cavalcade of smaller investors has been exhorting each other on the internet to keep the stock's momentum flying toward the moon. Many are pitching it as a battle of regular people versus hedge funds and big Wall Street firms.

The stock, which closed out 2020 at $18.84 per share, finished the day at $76.79 after trading was halted multiple times due to volatility. At one point, it climbed to nearly $160, a record high.

You read that correctly. GameStop, which is expected to lose money this year and next, has more than quadrupled in value in under a month because it's effectively become a meme stock. Since the beginning of 2020, it's jumped more than 1,100%, outpacing even Tesla's gains. Shares are up another 20% in premarket trading.

Investors on social media had been arguing that GameStop was seriously undervalued and cheered earlier this month when the company added Chewy founder Ryan Cohen, who has been pushing a digital overhaul, to its board. Now, the focus is on momentum, as small investors hope the hype can help the stock keep rising.

It's evident, however, that the saga has grown into much more than an argument over the future of a video game retailer, or the merits of different trading approaches. As no-fee apps like Robinhood democratize access to financial markets, some are reading it as a generational fight between the old and new guard of the investing world.

Users on Reddit cheered when veteran short seller Citron Research said it would stop commenting on the stock, citing harassment from GameStop's backers. Melvin Capital Management, which bet against GameStop's rise, has had to accept an infusion of cash after suffering steep losses, the Wall Street Journal reports.

"As someone who started trading stocks in the late '90s in college, I would always remember watching when the small retail trading groups would get crushed by hedge funds and savvy short-sellers," Oanda analyst Edward Moya said in a note to clients this week. "What happened with GameStop's stock is a reminder of how times are changing."

David certainly now has Goliath's attention.

"Starts opening r/WSB with my usual morning tabs," market strategist Michael Antonelli of R.W. Baird tweeted Monday, referring to the Reddit message board where much of the GameStop action has been coordinated.

Traders on such platforms have been plugging other stocks with major results, too. BlackBerry shares, another fan favorite, are up more than 170% in 2021. They jumped 28% on Monday alone.

Big picture: The wisdom of such trading decisions is certainly debatable. After all, it's near impossible to argue that GameStop's value has actually increased exponentially in a matter of weeks. Some gains are also attributable to a so-called "short squeeze," as those who bet against the stock rush to buy in so they can cover some of their losses.

But once the GameStop dust settles, expect Wall Street's asset managers to watch where the retail trading hive mind wanders next. Clearly, it can have an impact.

The Associated Press contributed.

The decision by security markets to restrict trading on stocks like GameStop sparked a rare moment of unity between conservatives and progressives on Capitol Hill Thursday.

Lawmakers from across the political spectrum — from the left-wing progressive House caucus known as "The Squad" to right-wing Senators who identify as "Constitutional conservatives" — skewered platforms like Robinhood and TD Ameritrade, accusing them of siding with Wall Street elitists instead of Middle-Class America.

Rep. Rashida Tlaib, D-Michigan, a progressive Democrat and member of "The Squad," called for House Democrats to investigate Robinhood's decision to halt trading on GameStop stock.

"They're blocking the ability to trade to protect Wall St. hedge funds, stealing millions of dollars from their users to protect people who've used the stock market as a casino for decades," Tlaib said.

Rep. Alexandria Ocasio-Cortez, D-New York, a fellow "Squad" member and a member of the House Financial Services Committee, said she would support an investigation.

"We now need to know more about @RobinhoodApp's decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit," she said.

Ocasio-Cortez's tweet prompted a response from Sen. Ted Cruz, R-Texas, who said he "fully" agreed.

It's rare to see Ocasio-Cortez and Cruz reach an agreement on social media. The two often spar on Twitter on topics like the Paris climate agreement and the pro-Trump riot at the U.S. Capitol.

Robinhood — a trading platform that says it aims to "democratize" market trading — announced on Thursday that it was restricting trades on GameStop, BlackBerry and several other stocks that have seen unsual activity in recent days due to "recent volatility."

The meteoric rise of GameStop stock was fueled by amateur or part-time traders who banded together on social media and used apps like Robinhood to spoil Wall Street hedge funds' bets that the retailer's stock would tank. Hedge fund investors who bet against GameStop lost billions of dollars this week alone.

The decision is also causing the New York attorney general to investigate.

This article provides information and education for investors. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks or securities.

Amid all the freneticism of the Reddit-hedge fund battle, a simple fact seems to have gone unnoticed: It means very little to the majority of investors. Your 401(k) is probably fine, and your IRA is still doing its thing.

To fully understand why that’s the case, let’s look at how we got here, and what it means for average investors going forward.

What the hedge just happened?

Hedge funds are investment vehicles that pool money from wealthy individuals. They’re less regulated than the common mutual fund, giving the firms that manage hedge funds a bit more latitude to perform high-risk investing maneuvers.

One such strategy is short selling. When you “short a stock,” you’re betting the price of that stock will fall. You borrow shares from your broker, then sell them immediately. When the stock price falls, you buy the shares back, return them to the broker and pocket the difference in price as profit.

But if the stock price rises, you could be in serious trouble. Imagine selling the borrowed stock for $10, then watching its price rise to $50. You’re on the hook to return those shares, which means buying them back at the higher price and taking a loss. What happens if the stock surges to $400? That’s what hedge funds just found out.

GameStop + hedge funds + short selling

GameStop is a brick and mortar store that sells video games — hardly the paragon of a future-proof company. Some hedge funds believed the company was in dire straits, and that its stock price — which was around $10 in the fall of 2020 but had been trading at around $4 for most of the year — would fall. They shorted GameStop, expecting to make money when it did.

… and then there was Reddit

Reddit is basically a chatroom broken into groups by category, called subreddits. Members of one subreddit, known as WallStreetBets, are known for irreverently, self-deprecatingly and sometimes offensively posting their investment exploits — both good and bad.

When WSB members caught wind of the shorts against GameStop, they saw it as an opportunity to take on what they perceived as Wall Street greed through what’s known as a short squeeze. They started buying up GameStop stock, driving the price higher, knowing it could cause a potentially multimillion-dollar headache for the hedge funds that shorted the stock and would be forced to buy it back at the inflated price.

Further fanning the flames of Reddit vs. Wall Street, on Jan. 28, a handful of brokers — including the investing app Robinhood — temporarily restricted retail investors from trading several stocks, including GameStop, while hedge funds and other institutional investors carried on as usual.

Should I be concerned about my investments?

This whole calamity will sting some investors, but most likely not you. The ones who will lose the most from this will be the short sellers who were forced to cover their positions and speculators who bought in at an exorbitant price, according to Aaron Sherman, president of Odyssey Group Wealth Advisors in Lancaster, Pennsylvania.

“An average retail investor should not be impacted by this if they are invested in a well-diversified portfolio that appropriately reflects their risk tolerance,” Sherman said in an email interview.

He added that this particular phenomenon, which was centered around a few individual stocks, is a clear example of why diversification is so important.

“The best way to achieve market gains while limiting volatility is to invest in diversified low-cost funds that will not be unduly influenced by pricing abnormalities in one stock or another,” he said. “Taking part in these short squeezes is pure gambling and should not be a part of anybody’s investment strategy for retirement.”

And if you’re having FOMO for missing the action, there’s no guarantee that message-board intel would have turned into profit. “The ones who will benefit the most are the Reddit users that initiated the frenzy — if and only if they manage to exit their position at the right time,” Sherman said.

Simply put, most individual investors are unlikely to benefit from this, and equally unlikely to see a negative impact on their 401(k), IRA or other long-term investment portfolio.

So, I shouldn’t let this sideline me?

If you’re not currently investing because you’re worried it’s too risky, this kind of news story doesn’t help. According to Sherman, the whole episode does offer an interesting truth: A group of people with a specific agenda can, in fact, influence the price of a stock one way or another.

The key word there is “stock.” Investing in individual stocks, especially based on an online tip, is always going to be risky. But that’s no reason to sit out the stock market.

“That doesn’t mean that the market as a whole is not safe to invest in, but rather that investors should invest in well-diversified funds (exchange-traded funds and mutual funds) rather than exposing themselves to the whims of a small group of investors in an individual stock,” Sherman said.

By putting together a long-term investment plan built on highly diversified ETFs and mutual funds, investors can take solace in knowing their retirement funds or savings won’t be wiped out by concentrated and rare market disturbances — including online stunts.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

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Chris Davis writes for NerdWallet. Email: cdavis@nerdwallet.com.

Trading platform Robinhood lifted restrictions on trading shares of GameStop Corp. and AMC Entertainment Inc. late Thursday.“There are currently no temporary limits to increasing your positions,” Robinhood said on its website Thursday night.The news comes following a roller-coaster period last week. Highly volatile trading of GameStop and other stocks erupted when amateur traders, many gathering on the Reddit forum r/wallstreetbets, took advantage of the heavy short selling on underdog stocks like GameStop, and invested heftily, spoiling short-seller's positions.Robinhood users became irate at the service, some even bringing lawsuits, when the trading platform restricted trading of 50 highly volatile stocks that were majorly shorted. Robinhood eased up on the restrictions Sunday, bringing that number down to eight. Still, GameStop and AMC remained on their list. The relaxing of restrictions comes as GameStop, AMC and other stock, once propped up by the hype of mass-investment, seem to be coming down.GameStop had a 500-share purchase limit earlier Thursday, and AMC had a 5,500-share limit.

There was a lot to unpack in the deluge of news this week about GameStop, the stock market, Reddit groups, trading apps and hedge funds. If it all seemed like too much, we can't blame you for tuning out.

While we don't know just how the so-called Reddit rebellion will change the future of investing, it's safe to say Wall Street will never be the same.

Here are five key things you need to know about Wall Street's wild week.

1. IT'S A DAVID VS GOLIATH STORY

At the heart of the GameStop saga is a struggle between two drastically different groups of investors: A band of amateur day traders versus a bunch of Wall Street pros known as short-sellers.

The Davids, in this case, are the mostly young day traders who congregate on the Reddit page WallStreetBets — aka the Reddit army, or the Reddit mob, depending on your point of view. "They have seen the rich get extremely rich by taking advantage of cheap money, and they want to get their piece as well," said Richard Fisher, the former president of the Dallas Federal Reserve.

Their mission has two main goals: Drive up stock prices to score profits for themselves, and at the same time, force the establishment investors to abandon bearish bets against struggling companies such as GameStop, AMC, Macy's and several others.

The Goliaths are mostly hedge funds who are shorting those stocks — in other words, big-shot investors placing bets that those shares will crash. They are also the Wall Street elite upon whom millions of investors rely to make smart decisions to boost their portfolios. But working in an industry associated with the house-of-cards system that created the 2008 financial crisis, these giants are not exactly beloved. Posts on the WallStreetBets subreddit openly relish watching short-sellers lose billions of dollars.

2. HOW THE GAMESTOP RALLY STARTED

The WallStreetBets community, which now boasts some 5 million followers, has been around since 2012. Describing itself as if "4chan found a Bloomberg terminal," the forum's giddy nihilism, inscrutable language and acerbic memes have fueled a war on a perceived corrupted mainstream.

The group noticed that GameStop, the struggling brick-and-mortar video game retailer, was heavily shorted by hedge funds. (The consensus on Wall Street seemed to be that GameStop would soon go the way of Blockbuster.)

Reddit investors took a different view from the short-sellers, however, and began buying up shares of the company that they believed were undervalued.

3. WHY IT BLEW UP

Although it had been building for a while, the rally really took off on Monday, Jan. 11, when GameStop announced three new directors would join its board, including Chewy co-founder Ryan Cohen. Investors liked Cohen brought digital experience to the table, something GameStop desperately needs, as video games go digital and malls continue their unrelenting slump into irrelevance.

GameStop's stock rose a little less than 13% that day. But this wasn't a normal, momentary stock surge. Two days later, it rose 57%. Then 27%...and so on. The Reddit crowd also drove huge jumps in AMC, BlackBerry, Macy's and other stocks that were heavily shorted.

As of Friday, GameStop's stock was up a jaw-dropping 1,587% since the beginning of January.

For perspective: One year ago, a single share cost about $4. It's now about $150.

The surge ultimately had little or nothing to do with GameStop's strength as a business. As investors following the Reddit group bought a ton of GameStop options, short-sellers were forced to buy shares to cover their losing bids — thus boosting the share price even further. This is what's known as a short squeeze.

Millions of people, including Elon Musk, chimed in.

It quickly became "a populist uprising armed with no-fee brokerage accounts instead of pitchforks," as CNN's Christine Romans put it. And the only ones crying foul were the "sophisticated" Wall Street players.

"The irony is delicious," Romans writes. "An online flash mob beats Wall Street insiders at their own game."

4. THE ROBINHOOD BACKLASH

On Tuesday, GameStop was the most traded stock on the planet. Then Robinhood crashed the party.

Thursday morning, citing extreme volatility, the free trading app favored by millions of amateur investors suspended trading of the red-hot Reddit darlings. That left the WSB crowd with just two options: hold or sell. Meanwhile institutional investors, who don't need Robinhood to execute trades, were able to carry on.

GameStop shares lost more than 44% of their value on Thursday after surging nearly 40% at one point earlier in the day.

The backlash was swift. Those who'd been minting money on their GameStop stock positions were, to put it mildly, furious. The consensus on social media seemed to be that Robinhood, which built its brand on "democratizing" investing, appeared to be caving to pressure from powerful institutions on Wall Street.

Congresswoman Alexandria Ocasio-Cortez called the decision "unacceptable." One Reddit user swiftly filed a class-action lawsuit, claiming Robinhood rigged the market against its customers.

Robinhood relented Thursday night, saying it would resume "limited" buys on the stocks the next day. It also tapped $1 billion in cash from its private investors, signaling it was short on cash.

On Friday morning, the GameStop euphoria was back. The stock opened up roughly 100%.

5. THE BUBBLE WILL BURST...EVENTUALLY

There's an argument to be made that GameStop was undervalued, but hardly anyone believes that GameStop, BlackBerry, Macy's, AMC or any of the other companies that the Reddit crowd is promoting have the fundamentals to support such sky-high prices. At some point, reality will set in.

But that's the problem with bubbles — get out too early, and you lose at a chance to cash out on top. So GameStop keeps surging ... until it doesn't.

"Someone is going to get hurt," said Fisher, the former Dallas Fed president. "As happens with crowd behavior, you end up having people come in at the end at a very high price and getting burned."

The Securities and Exchange Commission, the agency that regulates Wall Street, said it will "closely review" actions by trading platforms to restrict transactions.