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Retail Investing: Boon or Bane?

GameStop at its peak was the world’s largest video game retailer, with its stock priced at around $60 a share in 2006. The precipitous decline of physical retail due to the pandemic and the prevalence of Amazon and digital video game sales led to GameStop being valued at only $3 a share in August 2020. Institutional investors, seeing an opportunity, heavily shorted the stock, to over 140% of the available float. Unfortunately for these heavyweight investors, Redditors on the subreddit r/wallstreetbets took note, and attempted to execute a short squeeze, driving up the stock to an eventual high of $483, causing Melvin Capital, a hedge fund, to lose over $4.5bn.

Who were these investors? 

Retail investors are amateur investors – the analog to institutional investors. The key differences between these groups are portfolio sizes and investing knowledge, and the fact that retail investors are trading with their own money. Until recently, these investors were locked out of the stock market, due to high commissions and brokerage fees, but the recent rise of digital platforms like Robinhood with no-minimum investment accounts and zero-commission options has made investing the most accessible it has ever been.

These investors generally fit certain criteria: they are young, mostly new to the stock market and they invest far smaller amounts than institutional investors; they’re more likely to shun traditional data and invest on personal affinity or social media tips and research. 

In January 2021, equities and options trades reached record volumes as over six million people downloaded trading apps. Bloomberg Intelligence estimates that around 23% of all equity trading in the US was conducted by retail investors — twice the amount of 2019 and almost equivalent to all hedge funds and mutual funds combined. 

Democratising finance

The world of finance has long been viewed as an elusive realm of the super-wealthy and the narrative of “democratising” finance has seen a large buy-in, especially among the youth. The disruptive, innovative and agile solutions of fintech companies have allowed access to banking and investing solutions to large swathes of the population. However, this democratisation has been accompanied by the prevalence of gamification and the YOLO narrative, enticing investors to gamble large amounts of their money for a slim probability of success. While the narrative of people taking their financial futures into their own hands is a strong one, the challenge is ensuring that people are investing carefully and responsibly.

The dark side of retail investing

There have been several instances of mistakes, misinformation or just plain fraud emanating from the retail investing boom. A 30-year old investor on Robinhood received a $800,000 tax bill from the IRS after making $45,000 in profit due to legislation known as the wash sale rule. The SEC recently filed charges against a trader who spread misinformation about a company via 120 tweets on Twitter. He owned 41 million shares in the company and the stock price rose over 4,000%, netting him over a million dollars in profit. Elon Musk tweeting “use Signal” led to the share price of Signal Advance, a medical devices company, shooting up by 438% as retail investors confused this for the messaging app with the same name.

How does it affect the market?

While the 1,645% spike in GameStop’s share price might have been an extreme example, there are countless other examples in recent times. AMC Entertainment Holdings rose by 2,500%. Digital World Acquisition Corp, a SPAC rumoured to take Donald Trump’s social media company public, rose 800% in one week. Corsair Gaming rose 33% overnight. These examples are only the tip of the iceberg. In January 2021, penny stocks accounted for over 33.9% of traded share volume, up from 15.3% in November 2020.

The efficient market hypothesis, which is based on the assumptions of rational actors and company fundamentals, ceases to operate in a world where investment decisions are driven by emotions and memes. Institutional and other long-term investors now need to consider the effects of this new group of investors while making investment decisions. 

Responsible decision-making

Retail broker eToro reported that over one-third of the five million users on its platform joined in 2020, while Charles Schwab found that 15% of current retail investors began investing in 2020. While making investing accessible to new, underserved investors is a net good on the surface, this accessibility carries a greater responsibility for governments, regulators and educators to inform investors about the risks they take.

Many financial institutions have started promoting financial literacy through education and coaching. eToro has a comprehensive Education section on its website that walks investors through the basics of investing. Public, a “social network for investing” allows traders to share their portfolios, while SoFi is built around the idea of social trading. Commonstock, a “community for knowledge” doesn’t facilitate trading but is a forum for a discussion and critique of investment theses.

The main question now is whether retail investing is a passing fad brought about by the specific circumstances of last year — lockdowns and stimulus checks with no entertainment, or a more permanent shift towards financial independence. It is likely that the technological developments that propelled this growth will likely remain in place and commission-free trading will continue to excite retail investors.  

Sources

https://www.ft.com/content/7a91e3ea-b9ec-4611-9a03-a8dd3b8bddb5

https://www.ft.com/content/d87c6631-55f0-4897-9634-bf0ad969e27d

https://abcnews.go.com/Business/gamestop-timeline-closer-saga-upended-wall-street/story?id=75617315

https://unitedfintech.com/blog/the-rise-of-retail-investing/

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