Rational Stock Trades and Irrational Stock Trades

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There has been a lot of excitement in the trading community. It seems that a number of hedge funds decided to short-sell the stock of companies they thought were going to go down, and as a result could damage the company and possibly drive it out of business.

At the same time there was a Reddit subreddit called /r/WallStreetBets with about 6 million members. One of their members noticed the short action, and decided to stick it to the hedge funds, buy buying up the stock they were selling in addition to an additional number of shares driving the price up. Many more people at WallStreetBets got in on the act and all of a sudden GameStop stock began to rocket.

When you buy a stock, the only risk you have is 100% of what you paid for the stock. When you short-sell a stock, there is no limit to the amount you can lose. This is why I NEVER short-sell stock, nor buy options on a margin.

The curtain has been pulled back.

The Wall Street fat-cats were losing billions (with a “B”) on this, and the WSB players were making a ton on paper. What happened next drew the curtain away from the inner workings of our current oligarchy.

Reddit temporarily closed down the Wall Street Bets forum. They blamed “racism” and “hate speech”. But based on the timing, it doesn’t take a genius to figure out what happened.

The next thing that happened is that the Robinhood app (which many of the retail stock traders were using) stopped allowing buying of $GME*. They would allow you to sell, but you could not buy which protected the hedge funds position. A great quote I heard was: “You’re more like the Sheriff of Nottingham playing dress-up, than Robin Hood”.

The Wall Street Bets people behaved in an irrational manner to achieve a rational purpose. Wall Street is built on the premise that people trade for rational reasons, which is basically to make money. Their computer systems make trades so fast, that many of them build their offices closer to communication hubs to they can take advantage of the extra micro-seconds. When you begin to trade irrationally, especially en-masse, the system doesn’t know how to react.

So now the Wall Street types who have been using the system to screw the little guy for ages, have gotten a taste of their own medicine. We have also seen how Big Finance, Big Business, and Big Government work together to crush the little guy. Irrational trades from people who don’t care if they lose their money breaks the system, and the Wall Street types are going to be crying to government for regulation (and accompanying those requests with fat campaign checks).

Our eyes have been opened. Now, what are we going to do about it?

* TD Ameritrade allowed both buying and selling, but they restricted certain kinds of transactions such as short-sales, and buying options on the margin. Those trades that allow you to use money you don’t have.