Jan 21, 2021 - Economy

How high-risk traders are using Reddit and TikTok to scalp huge profits

Illustration of three dollar signs rendered similarly to the TikTok logo

Illustration: Sarah Grillo/Axios

One of the most high-risk, high-return trading strategies of the moment is also the most democratic: Buying the stocks being pumped up on Reddit and TikTok, and then selling them for a huge short-term profit.

The intrigue: While most active trading strategies require expensive professional-grade software, this is a strategy that’s accessible to anybody who's Extremely Online.

Driving the news: The hot stock of late has been GameStop, a beleaguered brick-and-mortar videogame store based mostly in shopping malls and struggling in a world where games — like all software these days — are mostly downloaded rather than bought.

  • The five-year chart of the company's stock looks exactly like you'd expect — until this summer, when Reddit started getting interested.
Source: FactSet; Chart: Axios Visuals

How it works: Remember how the TikTok #teens bought up all the tickets to the Trump rally in Tulsa and left it with a sea of empty seats? Imagine that, but for profit.

  • The trick is to find a stock like GameStop that has a lot of short interest, and start buying. If enough people do so, then eventually the shorts will be forced to cover their positions by buying back the stock, which in turn sends it even higher — a classic short squeeze.
  • GameStop became a game itself, of amateur investors versus the pros. Every time one set of professional short sellers would capitulate and cover, another set would arrive, betting that this time the stock couldn't rise any further.
  • The amateurs are winning the game so far, helped by the tailwind of a broad stock-market rally.

Between the lines: The investment strategy here is very simple: "Respect the pump," or "I see a stock going up, and I buy it, and then I watch it until it stops going up, and I sell it." Old-fashioned concepts like valuation are mostly ignored.

  • The most respected traders don't even bother buying the stock. Instead they buy out-of-the-money call options for pennies, giving them enormous leverage and maximizing their upside.
  • What they're saying: "I'm a believer in the basic momentum strategy," says AQR's Cliff Asness, "but using it and it alone without any idea of value is very dangerous. I would bet a lot of these traders do it way too idiosyncratically (a few positions and not a diversified portfolio), making it much more dangerous, and likely keep adding to it until they eventually blow up."

The bottom line: The TikTok teens might not win in the long term, but their short-term gains can be astonishing.

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