GameStop Stock Rally vs Shorting by Hedge Funds Reflects U.S. Disparities

The headquarters of the U.S. Securities and Exchange Commission (SEC) are seen in Washington, July 6, 2009.

Trading by a group of individual investors linked via social media in the United States has rocked the stock market. It is vital to discuss how regulations should be adapted to the times.

In late January, prices of shares in GameStop Corp., a U.S. video game retail chain, surged on the U.S. stock market. Although the company posted a loss due to the novel coronavirus pandemic, its stock price at one point rose to more than 20 times what it was at the end of last year.

Behind the soaring price was a group of individual investors who met on a forum on social media platform Reddit.

Hedge funds, which manage huge sums of money, were targeting GameStop’s shares for short selling to make a profit if the price falls. To counter this, individual investors posted a message on Reddit calling on users to buy GameStop shares.

Short selling is a transaction in which investors borrow shares that they speculate will decrease in value from securities companies and then sell them, before repurchasing them at a lower price to return the shares after a certain period to make a profit. However, if the price rises after the sale, these investors suffer a loss. This strategy is accepted as a usual transaction.

Hedge funds have suffered huge losses as a result of the GameStop action. The recent move by individual investors has struck a chord among those who described it as a rally by individuals against professional traders in the United States. This probably reflects widening disparities and the divisions in U.S. society.

While all-time highs on the U.S. stock market have contributed to the wealthy’s assets ballooning, the employment situation of low-income workers such as those in the service industry has deteriorated, deepening their dissatisfaction.

In addition, wider availability of commission-free stock trading apps has made investing quick and easy, and the widespread use of social media has made it easier for people to interact with each other. Such circumstances are probably the trigger for collective action like the one seen recently.

However, stock prices are essentially determined by a company’s performance and future prospects. It should be noted that trading with a game-playing mindset distorts the market and poses risks. GameStop shares have since fallen sharply.

Intentional stock price gouging is prohibited by law as an act of market manipulation. The U.S. Securities and Exchange Commission will reportedly step up its investigation of the recent move by individual investors. The U.S. Congress also plans to hold a hearing where it will summon a trading app owner, among others.

With stock prices hovering in the stratosphere, which can be described as a bubble, if trading like the recent case becomes widespread, it could lead to stock price volatility and destabilize the market.

Such a situation must be avoided, but there is a view that it is difficult to identify social media posts as an act of stock price manipulation. The current law does not assume any use of social media in buying and selling shares. It is probably time to establish relevant rules.

Short selling by hedge funds is also under scrutiny. It is hoped that ways to improve the soundness of the market, such as improving transparency, will be discussed.