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Reddit Warriors vs Wall Street

Right now, as I write this, there is a war between the Reddit Warriors, or “little guy” investors and the giant hedge fund WSB who is financed by the “little” who have trusted the hedge fund with their retirement plan.

The Reddit Warriors are individual investors who are most likely going to lose everything. These little guys are buying a stock at $100, $200, $300 even $400. It’s a worthless stock because GameStop, as a company, uses an outdated business model with horrible fundamentals, thus, no value.

I understand by buying these stocks the Reddit Warriors are trying to punish the hedge fund and teach Wall Street a lesson, but even if they take down this hedge fund, there are hundreds if not thousands more. Do they really think they can take them all down?

Let me explain what is going on here. The hedge fund is shorting the GameStop stock. What does that mean? It means they think the stock is overvalued. So, they short it. A short wins by selling a stock (GameStop) and profiting from the stock’s decline.

But here’s the tricky part, the hedge fund does not own the stock they are selling. How is this possible and why? First, they borrow the stock from a broker (that is the ‘How’). Why? Because they believe the stock price will drop. Once the stock price drops, the hedge fund buys the shares that they owe the broker. But now they are buying the shares at a lower price. So, the hedge fund returns the same number of stocks to their broker that they borrowed. They have satisfied their obligation to the broker.

 

The hedge fund’s profit is the delta between the original stocks they sold and the new, lower price of the stocks they purchased and returned to their broker.

Now, before you run out and try this strategy, remember that if you short a stock that pays a dividend, you must pay that dividend as long as you are owning the stock. Of course, if there is no dividend, there is no concern.

While this sounds like a safe strategy there is a danger. What happens if the stock price goes up? Now the hedge fund has to buy the stocks at a higher price and return the higher priced stocks to the broker. In that case, the hedge fund loses the money from the delta of the price they borrowed the stocks and the higher price they purchased them at.

Why doesn’t the hedge fund just hold on to the stocks until they do fall?

Their broker won’t let them. After the hedge fund has lost a certain amount of money, the broker can demand that the hedge fund sell their stocks and repay the broker or place more money in their account with the broker; this is to cover the loss they are potentially going to have when they purchase the higher priced stock. It is the way the broker protects itself. So, the hedge fund is forced to place more money in the broker’s account. This now makes the risk and danger to the hedge fund even higher.

Now, if the Reddit warriors keep forcing the GameStop price to go higher, the hedge fund must keep adding money into the broker account or bail out of the game and lose a ton of money. It’s a game of chicken. Will the hedge fund run out of money before the Reddit Warriors or will the Reddit warrior community run out first?

The sad part is either way the uneducated investor loses. If the hedge fund loses the fight, all their customers, all their 401(k)’s go bust. All the retirement plans they manage go bust and thousands or possibly millions of people are left with nothing to retire with. All the people who trusted this hedge fund with their money could end up working until they die or become homeless.

But, what if the Reddit warrior community runs out of money? The stock price can’t keep rising indefinitely because the stock itself is worthless. While the hedge fund wins, all those uneducated investors who thought GameStop was a good investment lose their shirts. They potentially placed all their money in this game of chicken and suddenly lost everything. If they purchased GameStop stocks at $100, $200 or $400 dollars and they drop to zero, they lost a lot of money and many of them will lose all or at least a lot of their money.

No matter who wins, someone will get hurt when they lose. It could be everyone who placed their money in the hands of the hedge funds so they would not have to take the time and energy to get educated or it could be the emotional Reddit warriors who saw a great opportunity to buy low and sell high because they did not take the time of energy to get financially educated.

This story is a shining example of the vital importance of financial education. Everyone wants the shortcut. The problem is shortcuts get you burned. Rather than look for the high-risk shortcut, take some time to learn about investing before you jump in. When this Reddit attack started, I wanted to join. I wanted to show Wall Street that they are not as mighty as they think they are. I called Andy tanner, my Rich Dad Stock advisor, and he taught me what was really going on and how it is creating a massive wave that will lead to a lot of people getting hurt. He educated me and then I took action… by not taking action.

I still love what the Reddit Warriors are doing. I just fear for them. I want to summarize by explaining why I love the Reddit Warriors and root for them. And I want to show you a strange similarity with cryptocurrencies.

The Reddit Warriors are angry against the systems and the bullies that run it. That is the same reason Bitcoin and the whole crypto-verse was created. They are fighting the governments and the Federal Reserve Bank’s monopoly on money, on the dollar.

There is a great difference though. While the Reddit bullies are trying to punish the Wall Street bullies, cryptocurrencies are not. Cryptocurrencies are a whole new form of money to separate your assets from all the bullies.

Again, both actions were created as a result of the monopolistic bullies, but the crypto-reaction is to separate from the bullies. The Reddit Warrior’s action is to punish the bullies. This is very different thinking.

While I root for the Reddit Warriors, also fear for them. And I think there are better ways to ‘fight the system’. I would get a lot of financial education from Andy before I jump in. And even though I see cryptocurrencies as another solution, just as much, if not more, education is required there.