COVID-19 and the Resurgence of Day Traders
Posted on Mar 26, 2021Sahana Ragunathan
Day trading activity has increased with the growth of online investment communities, which provide a forum for amateur participants to discuss highly speculative stock and option trading strategies. One such forum on the popular news and social site Reddit is Wallstreetbets, a platform where over 1.5 million users exchange ideas and discuss their gains and losses from trading every day.[1] While the community has been active for years, it gained widespread attention during the COVID-19 pandemic due to increased erratic trading patterns that led to wide surges in the market.[2] With users “bragging” about losses up to 2000% for increased online attention, exploiting glitches in trading platforms, and trading on superstitions, they were met with trepidation and distaste from Wall Street firms and institutional investors,[3] who tend to favor a more methodical approach to investing, driven equal parts by common sense and complex algorithms.[4] Even Jaime Rogozinski, the founder of Wallstreetbets, accepted that its members “don’t know what they’re doing, and don’t care that they don’t know what they are doing.”[5] Many who disapprove of this trading behavior advocated that the community be shut down for “market manipulation” since the herd-like mentality of its users has led to stock prices moving at significant levels.[6] However, despite the negative reception, the rise of retail investors may still have an overall positive impact on the financial markets.
First, there is value in democratizing trading and dissipation of financial intelligence and as a consequence, brokerage apps like Robinhood are becoming more commonplace today[7]. The term “democratization of finance” refers to the gradual process of removing control of the finance industry away from the select few big banks and financial institutions and distributing the power among the general public. [8] This shift in power is predominantly a result of advances in internet technology and zero-fee stock trading services that cater to a younger, less wealthy demographic. [9] In the words of one Robinhood spokesperson “Those who dismiss retail investors as ‘gamblers’ or ‘gamers’ perpetuate the myth that investing is only for the wealthy and highly educated.” [10]
Second, increased participation in the financial markets contributes to liquidity and stability.[11] High levels of liquidity arise when there is a significant level of trading activity and in turn, liquid market attracts more speculators and investors. At least one market veteran has commended the role of day traders in decreasing market volatility due to “less irregular trading dips and spikes”[12] While other commentators express concerns about market manipulation, in reality, most of the noise trading is likely to get canceled out.[13] Finally, addressing the criticism from Wall Street, online investment communities are constantly placing new restrictions on the type of discussions allowed, making it harder for investors to leverage the size of the community for stock pumping.[14]
Regardless of public perception and the impact on the financial markets, these young investors continue to grow in numbers every day.[15] Other market players should pay more attention to these communities instead of dismissing them as a passing fad. When market volatility cools in the aftermath of the COVID-19 virus, the financial world may need to reevaluate its approach to risk and investment, and reassess the overall stability of the institution, if it is one that can be so easily influenced by amateur day traders.
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[1] /r/wallstreetbets metrics, Metrics for Reddit (last visited Nov. 23, 2020) https://frontpagemetrics.com/r/wallstreetbets
[2] KS Anthony, Irrational Exuberance: An Interview With Wallstreetbets Founder Jaime Rogozinski, sumzero (March 02, 2020) https://sumzero.com/headlines/business_services/463-wsb
[3] Luke Kawa, Reddit’s Profane, Greedy Traders Are Shaking Up the Stock Market, Bloomberg Businessweek (Feb 26, 2020) https://www.bloomberg.com/news/articles/2020-02-26/reddit-s-profane-greedy-traders-are-shaking-up-the-stock-market
[4] Id.
[5] Jason Zweig, Playing the Market Has a Whole New Meaning, The Wall Street Journal (June 12, 2020) https://www.wsj.com/articles/playing-the-market-has-a-whole-new-meaning-11591974010
[6] Jamie Powell & Philip Stafford, Reddit: Bull Attack, Financial Times (Feb 20, 2020)
[7] Ismail Ertuk et al, The Democratization of Finance? Promises, Outcomes and Conditions, Review of International Political Economy (2007)
[8] What is the Democratisation of the Finance Industry and how Does Equity Crowdfunding Help it?, bricksave (May 04, 2017)
[9] John Constine, Robinhood Raises $13M to Democratize Stock Market With Zero-Commission Trading App, techcrunch (Sep 23, 2014) https://techcrunch.com/2014/09/23/robinhood-stock-app/
[10] Alicia Adamczyk, Trading apps like Robinhood are having a moment. But users should be careful, CNBC (Aug 21, 2020) https://www.cnbc.com/2020/08/21/robinhood-is-having-a-moment-users-should-be-careful.html
[11] Douglas J. Elliott, Market Liquidity: A Primer, Brookings (June 2015) https://www.brookings.edu/wp-content/uploads/2016/07/Market-Liquidity.pdf; See also What is Market Liquidity and Why is it Important?, IG (Feb 14, 2019) https://www.ig.com/en/trading-strategies/what-is-market-liquidity-and-why-is-it-important--190214
[12] Saloni Sardana, The Day-Trading Boom is a Welcome Phenomenon, Markets Insider (Aug 03, 2020)
[13] A. Shleifer & L. Summers, The Noise Trader Approach to Finance, The Journal of Economic Perspectives (2019) http://www.jstor.org/stable/1942888
[14] Stock pumping attempts to boost the price of a stock through false, misleading or greatly exaggerated statements. Once the price of the stock has been increased sufficiently, the promoters then sell the stock at high prices. See Pump and Dump Schemes, investor.gov (last visited Nov 23, 2020)https://www.investor.gov/protect-your-investments/fraud/types-fraud/pump-and-dump-schemes]
[15] r/Wallstreetbets stats, subreddit stats (last visited Nov 23, 2020) https://subredditstats.com/r/wallstreetbets