Reddit and Robinhood: How Young Investors Participate in the Market

A couple weeks ago, one Reddit thread was able to use hedge fund’s strategies against them. The aftermath revealed the topsy-turvy nature of an ever changing market and what participating at a young age can do for future security.

Part 1: The Young, Opportunistic Investor

His hand shakes as he holds his phone, seconds passing like minutes, Safari blatantly reminding him of how much money he put down. Should he add more? He has little time to decide. It’s the fourth quarter, and Golden State is supposed to win; his money says so. His friend is on the armchair next to him, eyes glued to the TV, willing San Antonio to pull ahead. There’s tension in the room, not from the fact that they’re each rooting for opposite teams, but because there’s money on the line. 

Junior Artur Pach has never bet on sports, but, like the Feb. 8 San Antonio v. Golden State game, he frequently witnesses his friends’ gambles. San Antonio won that night, namely due to a 3-pointer hit by point guard Dejounte Murray with 12.6 seconds remaining. Although his one friend lost money, when the clock hit 0:00, they could all still sigh a relief— it was over. 

“The bet will end once the game ends, and there will be a result,” Pach said. 

It is, in some ways, what makes sports betting reliable. There’s a sense of consistency in how each time you place a bet, you know there will be an end result, a clear win or loss. And while you can continue placing bets, game after game, you’re still allotted time to catch your breath, to think, to plan. 

The stock market is a different story. All beginning and end points come from you, the retail investor, and all bets are made in real-time, participating in a market that is continuously changing, every millisecond of the day. Pach, a finance major and accounting minor, gravitates towards stocks both for long-term savings goals and for quick trading that feels as intense as sports betting. 

Like many young people, he entered the world of stocks through Robinhood, an app “on a mission to democratize finance for all,” as their website proudly states next to short clips of a Black man going on a jog before dawn, a middle-aged woman dying her hair pink and a late teenager sitting in her neighborhood diner. These were also the clips featured in the company’s Super Bowl ad, and while they have nothing to do with finance, they still clearly reflect the image this company is after. They’re convinced that financial literacy doesn’t have to be confined to those few powerful people on Wall Street, that every retail investor (meaning you and me) can realize their financial potential. 

It hooked Pach, who signed up when he was 18, the minimum age required to have an account. He’d wake up early each day, sifting through Reddit and Discord and Youtube for tips about stocks that were on their way up. He’d make multiple trades in a day, each day, figuring out what he was doing along the way, most often through people online. Eventually, his two younger brothers joined in, getting custodial accounts (using their parent’s social security number), since they were underage. 

“My brothers and I used to wake up at six a.m.,” Pach said. “We’d talk to our buddies and see what stocks we were going to move the most that day.”

Today, three years into his investing, Pach relies more on TD Ameritrade for his trading, which is another, more reputable brokerage firm. He has both a standard investment account and a retirement investment account, but he’ll still use Robinhood when he hears of different tips online, knowing it’s not as serious as his investments on TD Ameritrade. 

One day this past summer, Pach was thumbing through the subreddit r/wallstreetbets, where he saw a random user post a tip about FedEx. The user said he was a FedEx employee, and even though America was in the middle of a pandemic, FedEx employees were working hard doing a lot of overtime. It wasn’t a guarantee that it meant great sales that term, but nothing ever is. So he went with it.

“So here’s a guy who, by chance, I saw his comment that FedEx workers were all working overtime, so I bet on FedEx going up,” Pach said. “And it did, and I made money.” 

In these scenarios, Pach said that he always cashes his shares in very shortly after. He’ll gain money from the price of each share going up, and he knew this from the Reddit tip, but if he waits too long to sell, then the price could fall back down again. That’s the beauty and horror of the stock market— it can, at any moment, rise or fall. 

“That’s where your discipline comes in,” Pach said. “As Warren Buffet said: ‘You have to be fearful when others are greedy.’”

Bidisha Chakrabarty, Ph.D., is a professor and department chair of finance at Saint Louis University, and while she thinks Robinhood has some advantages, she is also skeptical. The app is only resourceful to a certain extent. While it’s getting more people interested in investing and saving, she said that it’s the social media-esque structure that gives her pause.

“If Robinhood is reinforcing this gamification, and one of the most serious things you have to do in your life is to save for the future, then maybe it’s not the right thing,” Chakrabarty said. 

It’s part of the reason she and her colleagues pushed for a financial literacy course in the core curriculum, which they succeeded in doing. She equates financial knowledge with a happy and healthy life, which is something usually associated with being aware of your physical health, a comparison Chakrabarty does not make lightly. 

“We have a retirement crisis coming in this country in another few years,” Chakrabarty said. “Lots of people will retire, and the savings they have is minimal, and Social Security will not be able to fund everyone.”

The consequence of this is that Americans need to not only be responsible for their own retirement, but need to be equipped with the necessary tools to achieve that retirement. 

“It is quite disingenuous to say we have this huge, functioning market, look at how it’s growing, everybody should be okay,” Chakrabarty said. “No, the majority of people don’t even know how to invest, where to invest, how to even start.” 

Part 2: The Delusion of the Free Market

The United States is considered the most powerful country in the world, with the stock market at the cornerstone of our capitalistic economy, but the question remains: Who is this really benefiting? 

Pach says that he believes in the free market, that everyone should be able to do what they want with their money, but he also acknowledges that the free market is not what America has. The New York Times reported that last year, even through the pandemic, the stock market surged. But it was only a slim number of people whose pockets were growing—the top 10 percent of Americans in wealth controlled about 84 percent of the financial accounts holding stocks. 

“A free market is a concept,” Chakrabarty said. “You can’t really have a free market.”

Chakrabarty explains that a free market has the potential to exploit individuals who don’t have as great of knowledge as the insiders, those on Wall Street who are able to use hedge funds to manage their money, unaffected by great losses but propelled forward by great earnings. 

“We have to create some laws which protect everyone because no one has a choice to not invest these days,” Chakrabarty said. “You want to retire? You have to invest. You have to understand how to invest.”

It is these necessary laws and protections that keep America from becoming a free market. But no one in America is completely protected, which was exposed by one Reddit thread a couple weeks ago. To understand what the retail investors on r/wallstreetbets were able to accomplish, we first have to understand a couple key events that took place leading up to the turmoil. 

Chakrabarty explains that hedge funds are big money managers or investment firms, managing billions or hundreds of millions of dollars for generally wealthy investors. There are certain minimum requirements for who can invest through hedge funds because of the lack of regulations usually associated with them. Since the wealthy individuals using hedge funds are making risky bets that they can afford, there are less protections and restrictions in place, including with bets called short sales. This is what happened with the GameStop stock, the AMC stock and others. 

“A short sale is when you don’t own a security, but you can still sell it, which sounds a little bit contrarian,” Chakrabarty said. “You can’t sell a house which is not yours. In real life, we have to own something before we can sell it off. Financial markets differ in the sense that they allow you to sell something that you don’t own, a stock, for example.” 

Short sales are not typical bets; they are highly risky and usually only made for people with an excess of money.

With GameStop, investors predicted that the company’s price would be declining. To capitalize on this, a broker from a hedge fund borrowed shares of GameStop at a higher price, waiting for the price to go down so they could buy it and return the shares they borrowed. The profit they were hoping to collect would be the difference between the high sell price and the low buy price from the short sale. 

Let’s say the price of the share was $20 when you sell it. If the investor was right and the price goes down to $10, then the broker can buy it back and give it back to whomever they borrowed it from. 

“What you have done is you have sold it at $20 and bought it at $10 and gave it back,” Chakrabarty said. “That $10 you made is your profit.”

This is happening all the time with millions of shares. If you take the number of shares times the dollar amount of profit per share, then you can begin to see the money these hedge funds are reeling in when they are right. 

“They all thought that GameStop was going to go down, so they took enormous short positions,” Chakrabarty said. 

However, hedge funds are required to file, as public knowledge, what they are doing every quarter. This is when someone on r/wallstreetbets took notice. Through these hedge fund’s filings, this Reddit group was able to notice trends in the way the hedge funds were driving the price of GameStop down. What this online community suggested was using the same strategy to retaliate against the hedge funds.

The only difference was that instead of shorting these stocks, the Redditors were buying these stocks, and with the new increased demand of the stocks, the price was driven up. The platform most of these people were using was Robinhood. 

“For anyone who did a short sale, that is the worst news possible, because your profit depends on the price going down, not going up,” Chakrabarty said. “They were losing hundreds of millions of dollars…because now you have to buy at the higher price in the open market to replace the shares that you had short sold at the lower price.”

Pach says they stuck it to the man. 

“I think anyone can unite in this animosity towards these [hedge fund managers] who are crying, but they have three yachts,” Pach said. “I mean that just proves it’s not about politics, it’s about class.”

Shortly after, Robinhood restricted buying and selling GameStop shares, and currently there is speculation that these hedge funds were able to tell Robinhood and other brokerages that are designed for retail investors, to restrict this buying and selling of GameStop shares. 

“Congress is going to investigate this,” Chakrabarty said. “These big hedge funds have a lot of influence. These hedge funds have close connections with these brokerage platforms, especially Robinhood. Robinhood sells most of its orders to one hedge fund called Citadel.”

Chakrabarty notes that typically brokerages don’t have any laws they can implement to stop you from buying anything, which is where Robinhood could have gone wrong. Another aspect Congress will be investigating is whether collusion was involved. 

“You cannot collude with someone to drive down prices, and to these Redditors, it seemed very, very suspicious,” Chakrabarty said. “All of [the hedge funds] were doing the same thing at the same time.”

This collusion, at the same time, was what inspired a mimicking behavior in the Redditors. Because while Robinhood failed to “democratize” trading stocks, this online group was able to gather enough people together to make a meaningful difference in the market. 

“Social media has given a lot of power back to individual or retail traders, because previously, there was no way for retailers to communicate with each other,” Chakrabarty said. “There are just a few hedge funds. They know each other. Coordination is not difficult in those circles.”

It didn’t make the Redditors’ bets less risky, though. Instead of counting on the price of GameStop to go down, they were all betting that the price would be driven up. Pach thinks that a lot of the big bets that helped this effort were from rich kids who probably didn’t have much to lose. 

“They just do stupid things with their money for internet points, and they just want upvotes on Reddit, and they want awards on Reddit,” Pach said. “It’s funny because you know there are probably a bunch of really rich, privileged kids on there that have ten grand to play with.”

They had no idea if their plan would work. Chakrabarty says that it could have just as easily failed, which isn’t acknowledged enough. 

“My personal philosophy in understanding markets and looking at catastrophic failures that have happened in the markets is, if you don’t understand what you’re investing in, don’t invest,” Chakrabarty said. 

Pach told me about a time he was met with this reality. He had sold at a loss of $700, and while it wasn’t ideal, he said it wasn’t terrible, either. 

“You’re never really supposed to invest money that you can’t stand to lose,” Pach said.

While the retail investors were able to successfully drive up the price of the GameStop stock, they could have just as easily failed.

“If you buy a tanking stock, 99 out of 100 times, you are going to lose,” Chaklabarty said. “GameStop was the outlier this time. Maybe you’re missing out on a great opportunity, but maybe you’re also avoiding a huge catastrophe.”