Charlie McMillan Summons, Annabel Yenson
With Coronavirus and lockdown restrictions leaving many unemployed and forcing a shift to working from home, a tandem with record-low share markets in March has led many taking newfound hobbies in stocks, eager to make quick money. Leading the charge are Generation-Z who have become the face of the “Robinhood trader”. Not only are their unconventional methods of stock-picking creating price distortions in certain companies, it has also brought up the question of what sort of implications this new, maverik style of trading will have on the market and whether the influx of young traders has changed the ways we value traditional enterprises.
This new demographic of Robinhood traders consist of easily impressionable, young adults who are sifting through stocks and jumping at any promise of a great return, no matter how unsubstantiated those beliefs are. The methods of these traders are unconventional to say the least. Shares which are performing poorly or even declaring bankruptcy get inundated with orders based on the word of an overzealous trader. Some of these shares included the likes of J.C. Penney (JCPNQ) and Chesapeake Energy Corp (CHK), where the latter finally closed at $4.45, down more than $76.00 from its high in June.
Why are these traders so eager to invest in such blatantly obvious sinking ships? Robinhood traders hype these stocks up, causing many to pile into these shares, increasing demand and naturally driving prices upwards. In many cases those who have shorted the company fall victim to “short squeezes”; traders who sold borrowed stock in the hopes of buying them back at a lower price to capture a profit are instead forced to buy the stocks at a higher price to cut losses, thus driving the price even higher. But how does word of mouth get out in this age of social isolation and quarantine? Quite simply, Facebook.
As one of the FANGs, Facebook has a significant impact on the sharemarket, but its power of influence has emerged in another sense, namely the power of FOMO (fear of missing out). Facebook played a major role in the unprecedented 1,739% jump in price of penny stock Urban One (UONE). In two days, the share spiked from $2.18 to $36.42 for seemingly no other reason besides hopeful confidence and misplaced faith from millennials and Gen-Z day traders caught up in the romantics of a potential jump in share price.
Similarly, in the last days of July, Eastman Kodak Co. (KODK) soared some 2,760% in a matter of days on news of a government loan to help the company produce covid-19 treatment drugs. Robinhood users piled into the stock chasing the gains. The number of users holding KODK soared from 9,300 to 134,000. In the eternal words of Pitbull: “Picture that with a Kodak.”
As can be seen below, a significant number of users have been left holding the bag as a result of this irrational exuberance.
Flooding the Market
As the coronavirus pandemic got into full swing across the globe in March, brokerages saw the number of new accounts skyrocket. Robinhood added 3 million funded accounts in the first five months of 2020, eToro saw a 300% increase in new users, Fidelity added 1.2 million new clients, and Australian brokerage Stake saw its customer base surge 129% in the first six months of the year.
Popular conjecture is multiple factors led to this growth: cancellation of almost all sports in the first half of the year, a wide swathe of people gaining discretionary funds from government payments (JobKeeper, Centrelink Coronavirus supplement, Trump’s Coronavirus Relief Bill), the stock market entering the mainstream thanks to its collapse at an unprecedented speed, and last but not least, plenty of free time. The best exemplar of this behaviour was Dave Portnoy, founder of the Barstool Sports blog, who publicly catalogued his entry into the world of day trading.
This new volume of retail traders caused infamous mispricing. After filing for bankruptcy on 22 May, Hertz Global’s stock plummeted from $2.84 per share to $0.55. Two weeks later, lo and behold, the price of this bankrupt company rockets 890% reaching a high of $6.25. The number of Robinhood users holding the stock went from 44,000 to 170,000 at the stock’s zenith.
Momentum Fuels the Market
Naturally, this new generation is inexperienced in evaluating and buying stocks, betting against the odds of the sharemarket in an attempt to make it big on penny stocks with shaky foundations. It is probably a fool’s errand to attempt to divine the reason behind buying equity in a bankrupt company. Perhaps users logged on and saw a company which used to go for $3.00 and was now just $0.55 without thinking of the value they were getting for their money.
However, once the word is out that some are pioneering the stock, others clamour to get in on the company, regardless of how imminent and obvious the collapse is. As a result, the share price is driven upwards, resulting in a repeat cycle driven by the momentum of huge sudden demand bidding up the share price, until the penny drops and dollars revert back to cents. Whatever the driving force, it is clear that retail investors can create pretty egregious price distortions in the right circumstances.
Is this a new market paradigm? Does momentum fuel the market direction? Robinhood includes a list of the most popular stocks bought by its users. This tends to focus the undisciplined investors on a handful of names. Take Tesla Inc (TSLA), for instance. It is the 9th most owned stock by number of users with just over half a million shareholders from Robinhood. We can also see that TSLA rose almost 57% as of writing since they announced a 5-for-1 stock split without other significant news on operations.
One possible explanation for why retail investors are having such a disproportionate effect on prices is their use of options. The inherent leverage in options could allow the comparatively small amount of retail money sloshing around to have an outsized effect.
It is unclear whether the surge of retail accounts has uncovered a paradigm shift in market price discovery. Perhaps the biggest impact will be the behavioural impacts these new, young traders develop from their experiences in the current market. This is a relevant question because one day, these traders who cut their teeth during the coronavirus might inherit their parents’ wealth and exert an even greater influence on markets.
This new generation of traders have certainly left a heavy mark on the share market over the past 8 months, and naturally that brings up questions of whether this new style of fast paced, high risk trading will have a permanent effect on the way shares are evaluated and how the market moves stocks. The movements of these newcomers are more akin to that of a gambler rather than the traditional investor. In other words, the house tends to win.
According to Barclays, “More Robinhood customers moving into a stock has corresponded to lower returns, rather than higher.” and it is easy to predict that many will leave the market with burnt fingers. This being said, those with shorts must take this sort of gambling behaviour into account when predicting the potential fall of a stock. Whilst there may be no longevity to this generation’s method of trading, the short term consequences can be fatal and financially crippling if you find yourself on the wrong side of the fence.
Edited by Gary Palar, Dominic Holden and Sam Triantafillopoulos
Disclaimer: The views expressed in this article are solely that of the author’s, and do not necessarily reflect the position of UNIT nor the University of Melbourne. The advice given is general in nature and does not consider an individual’s personal financial circumstance. Transacting off this information is done so at one’s own risk, and individuals are encouraged to consult a finance professional before making investment decisions based off of this article.