Home News Explaining the complexity of the stock market with Lego minifigures

Explaining the complexity of the stock market with Lego minifigures

by Grayson Acri February 12, 2021
Explaining the complexity of the stock market with Lego minifigures

GameStop, Wall Street, and Reddit: a summary

By now you’ve probably seen what has been happening the past few weeks with GameStop, Wall Street, and Reddit.

Frankly, it’s a complex situation with some insane potential complications. Well, have no fear dear reader, for I am going to try and explain the situation in simple terms while still answering plenty of overarching questions.

First, an oversimplified explanation: users on a subreddit called r/wallstreetbets collectively decided to purchase GameStop (GME) stock in mass, which drove up the price per share and cost hedge funds who bet against GameStop lots of money.

Don’t worry, I’ll explain each part of that sentence.


Starting off, what is Reddit? It’s a social media site that focuses more on following communities rather than people. Imagine if Facebook only had groups, and your newsfeed was made solely of the groups you joined.

A group on Reddit is called a subreddit, they’re identified by starting with an r/. So for example a subreddit devoted to pictures of cute animals is called r/aww. Users are similarly identified by starting with u/.

These groups or subreddits are managed by moderators who manage the content for their group and establish rules for users to follow.

The subreddit in the spotlight is called r/wallstreetbets (Wall Street Bets). This group of self-described delinquents often use coarse language to make joke stocks into real purchases, often also posting the disastrous results of said jokes on their stock portfolios.

The subreddit’s description reads: “like 4chan found a Bloomberg terminal.” Their popularity exploded in April 2020 when the US stimulus checks for $600 landed, and lots of people decided to take that windfall to the trading floor to alleviate boredom and possibly make that $600 into something more reasonable.

Okay, now for the more technical stuff, the financial terminology.

r/wallstreetbets users employ a stock trading process called retail trading, which is the process of independent individuals purchasing small volumes of stock, the volume that a normal person is capable of (compared to a retirement portfolio or hedge fund, which have much more volume). They often use an app called Robinhood, which has had its problems with this community, but there are others from across the world. Essentially retail traders don’t trade stocks for a living, it’s more like purchasing a product, hence the terminology.

There is a process being employed by hedge funds and other Wall Street institutions called shorting a stock. Yes, it is the term “short” from the movie The Big Short, which is based on this mechanic. This process is why huge investment firms are losing money. It’s best explained in an analogy.

Imagine for a second that your friend collects Lego minifigures (the little plastic people). They have lots of different figures, ranging from Harry Potter all the way to Star Wars. You go onto eBay one day and see that this minifigure, the spaceman, is worth $10. You figure that the $10 is more than it will be worth in a year, after all the space race is over. Being the excellent friend you are, you ask to borrow the spaceman with the promise to return one to them in a year. They agree and lend you the figurine and you promptly sell it on eBay and pocket your $10, feeling pretty smug.

A year later you go onto eBay to fill your promise. One of two things is going to be true: 

1) Your original bet was right, the figure now costs $6, and once you purchase the figure to fulfill your obligation, you pocket a cool $4. Nice.

2) The SpaceX launches have increased the popularity of the spaceman, and now the figure costs $20 to replace. You made a promise so you’ve got to find the cash somewhere and just swallow the difference. Ouch. You’re out $10 from this transaction, but you made your promise so there’s that.

Here’s the fun part of that second scenario. The spaceman could cost anything, $20, $40, $100… You see the problem here. There’s no price ceiling. You could lose an infinite amount of money making your promise back. You only make money if the item goes down in price.

Institutional investors have been shorting GameStock stock for years. They believed that the retail games store would only fall farther and farther off, making them money. 

Up until a few days ago, that continued to be true. The members of r/wallstreetbets agreed to purchase large volumes of GameStop stock, driving up the price. This is basic economics; the more people want something, especially if there’s a limited quantity, the more money it’s worth.

The coordinated effort by the r/wallstreetbets community resulted in a stock price hike from about $77 on Jan. 25 to a peak of almost $350 on Jan. 27. That’s a 354 per cent increase.

So if you had a large bet that the GameStop price would keep going down and the day comes that your bet is due, and you saw that the price went up hundreds-fold, you’d be out a lot of money, and that’s exactly what happened.

 

 

Graphic by @ihooqstudio

Related Articles