The GameStop saga put the markets infrastructure under serious strain © REUTERS

The financial markets establishment massively underestimated the retail revolution in US stock markets.

For evidence, look no further than the 45-page myth-busting staff report issued this week by the Securities and Exchange Commission on January’s GameStop saga.

For those with short memories, this was one of those rare markets events that was chaotic and frankly fun enough to spill beyond the financial press.

TV, radio and the full range of non-specialist media were abuzz with the tale of an audacious assault by a plucky band of online warriors, who fired up the shares in a downtrodden US consoles retailer and claimed the scalps of bearish, too-clever-by-half hedge fund managers in the process. Then nerdy trading rules and blocked markets plumbing kicked in to stop them trading.

Depending who you believe, it was Occupy Wall St, it was David and Goliath, it was yet another example of the suits rigging the system against the little guy, or it was an outbreak of investment fever that quickly collided with reality.

The SEC’s report suggests that few if any of those interpretations are quite right. But it also makes clear that this event put the markets infrastructure under serious strain and undermined the principles of a stock market based on a “system of mutual trust and participation”. Whatever you think of GameStop, its share price should reflect those disagreements, and not market disruptions, the SEC says.

It is worth bearing in mind what kind of company GameStop is here. Avalon Penrose, a comedian, told me earlier this year that she once went to a GameStop store to exchange for cash a stash of video games that she had found in a bin (She didn’t get much money for them). Have-a-go traders nostalgic, contrarian or visionary enough to love the stock beg to differ, but at the time of the frenzy at least, this was not generally considered an exciting investment prospect.

Some of the facts and figures the regulator has pinned to the GameStop rally are breathtaking. Seemingly out of nowhere, with social media chatter about the stock bubbling up, the SEC says the number of people trading GameStop shares each day shot up to nearly 900,000 by January 27. That is equivalent to the entire population of Liverpool.

In the final full week of January, around 100m GameStop shares traded each day, up 1,400 per cent on the average from 2020. The shares gained 2,700 per cent from January 8 to 28. A clutch of other so-called meme stocks got tangled up in the rush.

Chart showing buying activity of traders with large short positions in GameStop

The David and Goliath analogy kicks in with the notion that online day traders, flush with boredom and spare cash from pandemic lockdowns, were deliberately targeting hedge funds that were betting against the company.

The SEC is not so sure that humbled hedge fund managers scrambling to unwind their bets really drove the stock higher, whatever the amateur traders believe.

At some points, yes, professional short sellers did cover their positions by buying back GameStop shares after wearing “significant losses”. But, the SEC adds, such buying was “a small fraction” of overall buying volume and the price continued to hold up even after the short covering would have been exhausted. “It was positive sentiment, not the buying-to-cover, that sustained the weeks-long price appreciation of GameStop stock,” it says.

The SEC also reinforced the message from Robinhood, the retail broker at the centre of this drama, that it did not switch off trading in response to pressure from shadowy hedge funds. Instead it paints a picture of a poorly understood clearing and settlement system that was simply unable, under its own rules of risk management, to keep facilitating the huge wave of one-way bets.

Whether any of this will change the mind of bombastic retail traders is another matter. Clearly, some are still bitter. Earlier this month, Citadel Securities decided to fight back with a sassy series of tweets after facing a barrage of outlandish online conspiracy theories regarding the supposedly Machiavellian market influence of its principal owner, Ken Griffin. Some tweeps and redditors seem convinced that Griffin orchestrated the GameStop affair to his own advantage, theorising that he pulled the strings that led to the stocks’ later descent back towards earth.

His Wikipedia page was temporarily altered to allege, among other things, that he was friends with “that one guy without a nose from Harry Potter, and the entire SEC department”. Sharp-suited public relations executives for Citadel Securities have a job on their hands to keep up with what the company has called “baseless theories”. It looks like Griffin does not know Voldemort after all.

Another GameStop will roll around at some point. Before it does, the SEC urges market participants to “reflect” on what went right and wrong in an effort to be better prepared. In other words, the system should strive to accommodate trading in markets now showing “broad participation”, even when the professionals consider it to be irrational. Citadel Securities’ PRs might also have some tips for the next supposed villain of the story.

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