The stock market turned into a spectacle this week to rival Super Bowl LV as retail investors and hedge funds faced game stop stocks. Tom Brady and Patrick Mahoms will have a tough time providing as much entertainment to viewers around the world as this latest step in financial market gambling.
Punya on stocks always has a game element: the thrill of betting and watching the game. But financial markets now offer opportunities for combat as well as entertainment. The fighting element was introduced with the proliferation of hedge funds who were actively in short stocks to hedge their positions. Extensive shorting – when you borrow a stock, sell it and hope to buy it back at a lower price – ensures that longs (stock owners) are set against shorts in a zero-sum game. With the story of the morality of good individual investors on Reddit fighting evil hedge funds shorting stocks, the game is over. What could be more fun than watching a deadly battle between individuals and organizations, outsiders and insiders, in a polytheistic moment?
How did financial markets gamble? There are many criminals, including employees who are fed up with being screened and socially marginalized on screens during epidemics, and low interest rates that fool traditional savings and borrow to buy stocks cheaper, but most importantly the resurgence of the retail investor. You can’t completely gamble the industry without finding the technology to approve a lot of new players.
Over the past five decades, institutional investors have become a dominant force in financial markets. The rise of fixed benefit schemes and subsequent workers in mutual funds invest in retirement assets and hedge funds which are transformed into fixed contribution schemes that promise more returns to pension schemes and endowment managers. But that changed two years ago.
A fundamental change in the business model of financial brokers brought back to retail investors: an increase in zero-commission trading. The commissions were already under pressure because new entrants – especially Robinhood – were funded by adventurous capitalists that the businessman was eager to find another industry to interrupt with capital. The brokerage realized that their business model was sideways. They don’t have to charge their customers commissions to make money; There was more money to make by No Charge their customers. The lure of “free” offered by Facebook and Google was much greater than the traditional business models.
As we have learned from the internet, what appears to be free is far from it. Just as Facebook and Google monetize user information by selling advertising, so do all brokerage information transferred to Robinhood and Zero-Cost Commissions. But there is a twist. Brokers do not sell their users information; They sell its lack. The basic problem for market makers in financial markets is that there is a risk of dealing with people with information – no one wants to trade with anyone with more information because they know they will lose. That problem is what gives rise to so-called bid-ask spreads (the difference between the price at which you can buy and sell an asset), as this spreads the prize market to producers due to the risk of transactions with knowledgeable traders.
Robinhood and other zero-value brokerages monetize their hold on people who are definitely unaware of active traders. They sell the business to new generation market makers, such as Citadel Securities, which pays for the ability to spread bidding without the risk of trading with knowledgeable traders. Retail investors trade for free, the new Wall Street pay generation like Citadel monetizes their ignorance, and the old-line investment banks that used to spread the word became like Goldman Sachs, with some combinations. Commercial Bank and Hedge Fund. The fun is by all means.
Gambling in the financial markets comes with many costs. This will end badly for retail investors, although it is not clear exactly when and how, and some will make money along the way. In the process, financial markets will do what they have done for centuries, though they have little to accept: unknowingly turning assets into information. Each bubble is associated with redistribution, and most of the alpha that is swayed by professional investors is nothing more than the benefits of time that are redistributed to other parties. The current populist moment in the financial markets, like many other populist moments, will only expand the redistribution towards the rich and the knowledgeable, when it indicates that the opposite is happening.
Even more is at stake for the real economy. Financial markets are meant to provide price signals that help allocate resources and provide methods for capitalizing capital from savers to firms that need capital. Gamification reduces important tasks to a side show. As retail investors consider their losses, they will lose confidence in the valuable functions offered by the financial markets.
Like Facebook, or any seemingly “free” market, putting Ginny back in the bottle won’t be straightforward. It is not clear how to regulate the market in which participants voluntarily trade their attention. Nothing is levied on individuals, and there is no edge to clear information that is being unfairly capitalized. Yet over time there will be losses and more damage to credibility in the financial markets. Until this is calculated, your long-term health will best serve not as a player but as a fan – if you’re playing what the players are doing, it can fill the stomach, i.e..