Major brokerages restricting trading in GameStop, AMC and other stocks in the wake of their meteoric rise over the past few days has caused critics to rail against what they call an example of a rigged financial system.
"Gotta admit it's really something to see Wall Streeters with a long history of treating our economy as a casino complain about a message board of posters also treating the market as a casino," Rep. Alexandria Ocasio-Cortez, D-N.Y., tweeted Wednesday.
Ocasio-Cortez is referring to the extraordinary story of GameStop trading that has played out on social media over the past few days. Fueled in part by a group of non-professional investors — called "retail" investors in the industry — on Reddit pushing shares higher and squeezing out hedge funds, the stock for the struggling video game retailer has surged dramatically.
That hurt hedge funds that were shorting the stock and are now left watching their losses mount. Short selling is a strategy in which investors borrow shares of the stock at a certain price under the expectation that its market value will be worth less when it's time to actually pay for those borrowed shares. In other words, several hedge funds bet on the stock prices dropping.
Retail investors on Reddit and Twitter, meanwhile, have celebrated the events as a "win" for the little guy against Wall Street.
Brokerages halting trades upsets investors
But brokerages catering to those same people, including Robinhood, Interactive Brokers, TD Ameritrade and others, began restricting users' ability to trade certain stocks Thursday amid the extreme volatility. Robinhood and Interactive Brokers also raised margin requirements on certain securities, which increases the amount of money an investor using leverage and derivatives is required to have in their brokerage account after a stock purchase.
"We continuously monitor the markets and make changes where necessary," Robinhood said on its blog. "In light of recent volatility, we are restricting transactions for certain securities," including AMC, GameStop, Nokia and others. In an update late Thursday, the company further explained its decision and said that the app planned to allow "limited buys" of the securities on Friday.
Interactive Brokers chairman Thomas Peterffy offered a similar explanation, saying the company curbed trading to help "safeguard the marketplace," as well as the brokerages themselves. When investors buy and sell using leverage, their trades are only backed by a fraction of the total cost, so it's possible they will incur losses greater than they're able to cover. If this happens, the brokerage can be on the hook to cover the loss.
The extreme volatility means prices are changing dramatically from one moment to the next, says Bryan Routledge, associate professor of finance at Carnegie Mellon University's Tepper School of Business.
"Robinhood caters to individual investors, so you can certainly imagine a situation where they want to offer some protection," says Routledge. "On the other side of that, annoying your client base is a business cost."
And the decision did enrage many retail investors, who view the situation as Wall Street not playing by its own rules once it started losing. Not only are the brokerages costing them money, they say, but, in the case of Robinhood specifically, they are reneging on their explicit promise to "democratize" investing.
Robinhood's decision underscores some people's belief that the deck is stacked against them, says Zach Abraham, founder and chief investment officer of Bulwark Capital Management, where he advises retail investors.
Abraham characterizes platforms restricting trades for retail investors as "an absolute travesty," noting that many of the Redditors' moves weren't just some "troll," but calculated based on their own research. The hedge funds made "bad calls," he says, and retail investors caught them on it.
"This is only going to perpetuate the wealth gap, and that the rich play by different rules," says Abraham, whose firm sold its positions in GameStop last week. "If the roles were reversed, nobody would be saying a thing."
Buyer beware
At the same time, the situation has morphed into a dangerous game for other retail investors who read into the recent hype but don't understand the risks involved in trading, Abraham says.
"This isn't some new riskless way for investors to make money," writes Dave Sekera, Morningstar's chief market strategist. "Once enough of the shorts have been flushed out, there won't be any new buyers to keep the stock price propped up, and, like a plane hitting an air pocket, the stock price will drop."
The stocks are currently "way over-priced," says Abraham. Getting in now on the news-making names of the past few days would be akin to gambling.
"I could not emphasize more clearly for retail investors: Take those names off your screen and look elsewhere," Abraham says. He predicts GameStop and other stocks will "blow up" in the coming days. "You just don't want to be messing around with these names today."
Check out:
- 'You will lose your money very quickly': What investors need to know about GameStop's stock surge
- Trading apps like Robinhood are having a moment. But users should be careful
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