Math, Magic, or Psychology? The Guerilla War for Wall Street Supremacy

Wall Street is a really exciting place these days, huh? There is a lot of weird arcane black magic that goes on within the byzantine halls of our financial empires. This wizardry is far beyond the ken of mortals like me, and so I have mostly ignored it. However, there has been a great upheaval in the fiscal firmament of late, and I have found myself sliding further and further into fascination with the intricate web of, well, bullshit, that keeps our investment giants wealthy and strong. One conclusion is inevitable and I type it here merely to hear the sound of it echo inside my own skull. 

Billionaires do not play by the same rules as the rest of us.

This, of course, should have been obvious. In my defense, I have always understood this. But watching what happened when a bunch of guerrilla investors attacked the richest and most powerful people among us has illustrated in concrete terms what has always been more of a conceptual understanding of this phenomenon. Let’s see if I can wrap my meager understanding of financial sorcery around it all, shall we?

The Stage:

Welcome to the world of high finance, dear reader. It is a place unlike any other you have ever been. What you think is real is not, and what you would assume is formless vapor drives billions of dollars back and forth with no effort whatsoever. Investment is neither science nor art. It’s magic. The magic of sophisticated computer algorithms and complex financial instruments wrought from game theory and good old-fashioned cons like 3-Card Monte. Except there are now 58,000 cards and the queen is a loosely-defined concept that only exists for brief moments at a time in any given space.

At the most basic level you have large companies that like to do well so their stock prices stay high. We are not going to deal with these right now. They are not the problem, here. Neither are most of the big name investment firms that deal in blue chips and long-term investing. In this article we will talk about the companies that trade in that stock to make a profit fast and hard. Specifically, we want to talk about hedge funds. What is a hedge fund? Glad you asked, because the definition is clear as mud. According to Investopedia, a hedge fund is a company that:

“… deals in alternative investments using pooled funds that employ different strategies to earn active returns, or alpha, for their investors. Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).

It is important to note that hedge funds are generally only accessible to accredited investors as they require less SEC regulations than other funds. One aspect that has set the hedge fund industry apart is the fact that hedge funds face less regulation than mutual funds and other investment vehicles.

KEY TAKEAWAYS

  • Hedge funds are actively managed alternative investments that may also utilize non-traditional investment strategies or asset classes.

Well. That does not help much at all, does it? Think of a hedge fund as the rogue cop in a bad 90’s action movie. He does not like to play by anyone’s rules and danger is his middle goddamn name. A hedge fund is a high-pressure boiler room where creative investors work out new and occasionally outlandish strategies for making money. They’re rebels, mavericks, ruthless gunslingers. Whatever. The point is that to play in this arena, you need nerves of steel, powerful computers, well-heeled investors, a couple of pet politicians, and a schill so smooth it’s frictionless. There is nothing illegal about what most hedge funds do… on paper. A major part of what a strong hedge fund does is to find loopholes and exploit weaknesses in regulations in ways that increase profits. They’re creative and aggressive, and that is not necessarily illegal. That’s gaming the system. This point will be important later.

What’s Happening?

Not quite Cowboy Bebop

Well, a bunch of idiots who get together on Reddit decided to buy a whole bunch of stock in Gamestop (GME) and AMC. The term for regular folks who buy stocks is “retail investor,” and most hedge fund types cannot say that without snickering into their $1,800-dollar handkerchiefs. Who cares about unwashed nerds buying up stocks of underperforming companies? No one, at first. Then lots of people started to care a whole lot when it became clear what those uppity peasants were really up to. 

You see, a bunch of hedge funds had been ‘shorting’ all those stocks.

What is shorting a stock? It’s when you borrow a bunch of stock you think is losing value to profit off the difference in sell price later. To make this work, the hedge fund needs to buy back a bunch of stock for a lower price than the price they borrowed it at (called “covering” their shorts). The problem facing a couple of these big hedge funds right now has a few different facets.

First: GME stock was shorted for more shares than actually existed. That should not be possible. But it is. How? Fucking magic. Basically, the hedges were so sure that the stock price was going to tank they shorted the same shares more than once. Think about that. Bask in the stupidity of it. There was almost no way for everyone to cover their shorts in the first place. Somebody was going to lose their ass no matter what, and the hedge funds did not care who because they were playing with other people’s money, anyway.

Second: The morons from Reddit are holding most of the shares they needed to buy and uh… they aren’t selling them for nickels. They are holding out for a big payday.

Economics 101 time! In the case of both AMC and GME stock, there is not currently a lot of SUPPLY. The hedge funds HAVE TO BUY BACK THE SHARES THEY BORROWED, no matter how expensive they become. With those contracts looming, there is now a ton of DEMAND for those stocks. I don’t want to dumb this down too far, but when you have a lot of DEMAND and very little SUPPLY for a thing, prices are gonna get to climbin’.

And climb they did. Gamestock shot to about 4,800% of the short price. This is called a “short squeeze’ and it sucks for you if you shorted that stock. The hedge funds lost their minds, and also a few BILLION dollars in value overnight. The retail investors smelled blood, and they set their sites on another stock that was heavily shorted: AMC.

This time the hedge funds were ready, though. Do you think they took that shit laying down? Hell no. Now things get a little dark.

There’s No Such Thing as a Short Ladder Attack!

The first salvo fired by Wall Street hedge funds in response to these coordinated short squeezes was their most basic. Several popular retail investing apps like Robin Hood suddenly stopped letting their customers buy AMC or GME stock. Period. They just said “Nope. Can’t do it. Nuh uh.” By cutting off the flow of regular joes gobbling up the stocks, they sliced off a huge chunk of the DEMAND that was driving the stock price up. If no one is buying (because you won’t let them), then the hedge funds who need that stock at a low price can breathe easier. Robin Hood is already being sued for this, and several very loud voices in the federal government are demanding answers. RobinHood has claimed that the sudden increase in volume exceeded their required deposits and so they HAD to shut off those stock trades. This may in fact be the case, but it does not excuse the fact that it is their responsibility to execute the trades as required by their customers and their responsibility to provide services as advertised. They did not, and they failed in a way that was suspiciously advantageous to the many hedge fund investors who had also invested in RobinHood. If that smells fishy to you, then your nose is working properly.

In tandem, the Discord server being used by many retail investors squeezing GME shorts was shut down for “hate speech.” The accusation is widely derided as laughable, and the influence of hell-heeled investors is suspected in the strange decision. The AMCstock subreddit disappeared for 36 hours as well, with no clear explanation for the absence. I suppose it could all be coincidental, but that is a lot of coincidences to parse.

Bullshido’s Discord server… for the time being, apparently.

The next bit of financial witchcraft employed in the war with Redditors was much more insidious. Overnight, lots and lots of AMC and GME stock trades were going through. Hundreds and thousands per second. This is not that abnormal. It’s called ”high-frequency trading.” Clever little bits of software buy and sell stocks rapid-fire to take advantage of tiny little fluctuations in the prices. High frequency trading is not illegal. Colluding with other investors to use HFTs to affect stock prices is. 

Where the hedge funds may have screwed up a little is in hiding their tracks. First they sent their little bots to beat the price downward by trading the stocks to each other at reduced prices. The actual volume of stock traded and the size of the individual positions stayed the same, but thousands of repeated trades at incrementally lower prices drove the average price downward. You can spot this manipulation when the stock price drops a lot on a high volume of trades that move very little actual stock. Normally, you need a lot of volume to see a big price change when actual market forces are in play. When a lot of people want to buy or sell a lot of something, the price fluctuates because a lot of that thing is being traded. That is not what is happening here. 

To make this trick work tons of these tiny little trades have to happen really really fast. Hundreds a second, even. Each time the bot sells the same stock for fraction of a penny less, slowly eroding the average strike price and bringing the reported stock price down. That is what happened (and is still happening) to AMC and GME. But these bots don’t really have the ability to randomize what they do because little of either stock is actually being traded. Rather, tiny bits of it are being traded OVER AND OVER AGAIN in a repeatable pattern. 

Behold the following two charts. These are the stock prices for GameStop and AMC on Feb 1st. Almost every single peak and valley is duplicated in real time, despite them trading at different price points and being different companies in wildly different markets.

It’s worse in after hours, because MOST retail investors cannot make trades after hours. During the day, retail investors can punch back by buying the stock when this pressure drives the price low (“buying the dip”). When that happens, demand comes up and the price starts to climb again. With very few retail investors trading after hours, the bots can run wild. 

Since AMC closed at 13.80 Feb 1, there has been a concerted attack on the stock during after hours trading. People have been calling this a “short ladder attack” and irritating lots of smug know-it-alls. There is no record of the term “short ladder attack” anywhere outside of the Reddit boards and this has caused a lot of poo-pooing. To many stock-savvy types it’s just high-frequency trading doing its thing. What’s the problem? We’ll get to that.

Is this illegal? Probably? Maybe? Hard to say. But what happens when the price drops? People get scared and sell to avoid losing more. Supply starts to go up, prices stay low, and the shorts get to cover at a lower price. The goal is to trick retail investors into selling at a lower price by making it look like the price was tumbling. Even if no one is really trading the stock and the price should not have moved at all.

Misinformation is Still Information, Right?

FIgures don’t lie, but liars often figure. The complexity of these investments makes them ripe for misinformation campaigns. A particularly troubling example of this occurred on Feb 9th. Let’s talk about Fintel.

Fintel is a big old financial reporting think tank. They monitor more than 9500 funds on Wall Street, and many funds and investors rely on their data to make important financial decisions. This data is the product they sell and why Fintel exists. Last week they committed a bit of an “oopsie” that they are very sorry about. What did they do?

They altered the short volume for two very volatile and heavily-shorted stocks: GME and AMC. They basically posted one set of stats on Feb 6, and then overnight just…changed them to exactly half the originally reported amount.

Why does this matter? Well, it did not happen to any other stocks they report on, and it was an oddly convenient error at an oddly convenient time. If you are a hedge fund, that is. You see, if a stock is heavily shorted, then rogue investors (poor people) can buy it up and squeeze the hedge funds for a higher stock price. If it’s not heavily shorted, this won’t work. Fintel’s little faux pas changed the short volume by half on two stocks that are being squeezed pretty damn hard right now, giving the impression there was a lot less squeezing…

They got caught, of course. Not by a regulatory body or eagle-eyed SEC official. No. It was a regular guy who suspected foul play and took the time to look.  He contacted Fintel and they replied with “yeah… we counted wrong. Sorry.”

More specifically, what Fintel did was to (accidentally?) alter their data in a way that is beneficial to hedge funds who shorted GME and AMC. They claim the current data is the correct data, except it’s radically different from what they had reported for MOST OF A YEAR up to that point. They changed it overnight on a weekend, where fewer people were likely to see it happen, too.

In the interests of objectivity, it is entirely possible that Fintel’s excuse of “whoops, our bad,” is legitimate. Mistakes get made all the time. Now picture yourself filing your taxes. At some point in doing so you make an honest mistake that nets you a big return. How will the IRS react when they catch that mistake? Will they care that you didn’t mean it? Or will they demand what you owe with interest and penalties?

The case of Fintel’s mistake falls into one of two categories: Gross negligence or outright collusion. It’s an ugly look that on it’s own would cause a rueful head shake. But when added to the high-frequency trading with no volume, retail platform shutdowns, and other market manipulations surrounding these stocks, Fintel’s mistake should not be treated so lightly.

If you or I made that kind of error, we’d be in jail.

Which Leads us to This:

What the actual fuck is going on in these hedge funds? There is a strange, fuzzy, nebulous line between clever gamesmanship and market manipulation that seems to have faded into outright invisibility. High Frequency Trading is literally a license to change a stock’s price any time you want. Wealthy investors have criminal levels of influence over the tools regular people use to participate in the stock market, and when that doesn’t work they can just lie with impunity. Let us not forget that in 2008 bad investments nearly destroyed the US economy. The taxpayers had to bail out several large (HUGE) companies just to prevent another great depression. Those bad actors are still rich and none of them are in jail. Thirteen years later and nothing has changed.

Well… something has changed. The veil of obscurity protecting these behaviors gets thinner every day. The Morlocks are getting smarter, and man, there are a lot of ‘em. I think the Eloi are getting nervous.

When a bunch of angry retail investors jumped into the same pool where the big funds swim and started to play by the same (lack of) rules, the response was predictable and disgusting. Market manipulation, purchase restrictions, collusion, manipulation, and outright lies were applied with no hesitation whatsoever. The sheer indignance of some hedge funds about the audacity of regular folks gaming the system in the exact same way they have been for years was telling. CNBC, Bloomberg, MSNBC and other media outlets were flush with angry billionaires calling for censorship of any place where people might talk about doing things to hurt their profits. Doing their part, most of these media outlets played along with the funds by refusing to acknowledge the bad behavior at play, and instead focussing on the recklessness of retail investors

This is not a photoshop.

It’s truly fascinating. Wall Street is now dealing with something it cannot automate or plug into a risk table: The sheer unshakeable stupidity of angry people with nothing to lose and a lot to gain. The average retail investor is playing with their savings account, not a multibillion-dollar portfolio. They can afford to be reckless. You don’t have to be Sun Tzu to understand where the hedge funds might have gotten in trouble, here. When you and your enemy both have a lot to lose, risk must be considered and effects measured to the fourth decimal point. There’s billions at stake for both sides, after all. When you are dealing with an opponent who does not care about the risk and just wants to see you bleed? Well, it turns out that is an altogether different thing. When there are millions of these frothing barbarians? Ouch. 

There is no hiding where we are at. Actions that would earn lengthy prison terms for you or me are being done a hundred times a day on Wall Street. The audacity of the players is simply breathtaking. When regular folks banded together to stick it to ‘em, the hedge funds did not even try to hide what they were doing. Why should they? The fines for their transgressions will be less than the losses they might take or the profits they may realize. Screwing over the little guy is part of the process and paying SEC fines is merely the cost of doing business. That is how little they respect the regular person and the rule of law. I suppose we always knew that, but watching it happen in real time is a touch disconcerting.

For historical context, ask a Roman about what happens when you exploit disgruntled barbarians with little to lose and much to gain. Whether or not the lying, manipulation, and securities fraud works this time, and it looks like it could, the game is probably changed forever.