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A story that I keep hearing about Gamestop Corp. stock is "Reddit beat up Wall Street". This narrative is an onion of wrong. It's based on an incorrect premise (Reddit vs Wall St), furthered by bad reasoning (this hurt hedge funds), fueled by misinformation (trading restrictions targeted retail traders), and supported by a minor conspiracy theory (RH customers are being front-run).

In general, I think writing about an ongoing event is bad (encourages sensationalism), but in this case, I think what I say here will be a lot more convincing if I write it before it all ends in tears.

Reddit vs Wall Street

This, or slightly more coherently, "Retail investors that organized on WSB vs hedge funds", is not a representation of reality.

Let's look at Citadel's reported market flows for GME for the week of Jan 25:

Retail traders were buying GME slightly more than they were selling on Monday. They were selling slightly more than they were buying on Tuesday, Wednesday, and Thursday. Buying dropped on Thursday after discount brokerages restricted opening new positions on GME, but so did selling.

Also important to note is that Citadel reports that 29% of their order volume is retail (last column). The other 71% of trading activity in GME they see is from professionals. In order for the "Reddit vs Wall Street" part of the narrative to be true, the price must be moved primarily by retail traders (the market share column needs to be higher) and the price must be moved up by retail traders (the buy column needs to be higher than the sell column). (Also, I think in order for that to happen, market makers like Citadel would have to get run over and struggle to provide liquidity.)

Hedge funds are hurt by GME volatility

At face value, this just doesn't even make sense. Two hedge funds (Melvin and Citron) have been hurt by this. Generalizing that to hedge-funds-as-a-class is propaganda. Reducing all of Wall Street to hedge-funds-as-a-class is lunacy.

But on another level, the narrative says that WSB organized a short squeeze to stick it to the hedge funds. The way you do that is you bid the price up and then sell to people with a short position, crashing the price. For that to be true, either the shorts must still be holding and the price is high (if the squeeze is ongoing) or the shorts were forced to close out and the price has crashed (if the squeeze was successful). But the short sellers are out and the price is still high. (OK, that's not true in the general sense: the 2 hedge funds that are part of this narrative have closed out, but the stock is still being shorted, unclear by whom.)

It seems reasonably clear that this is a pump-and-dump which, as always, leaves retail traders holding the bag of worthless shares at the end. It happens to involve a short squeeze, but the bigger effect on the price (and, therefore, what should be the bigger story) is the pump, not the squeeze.

Trading restrictions were intended to hurt retail traders

On Thu, Jan 28, Robinhood and other discount brokerages restricted their customers from opening new positions in GME. The narrative contends that this is because Wall Street is angry about people that aren't them "winning". AOC even bought into this narrative (though she also replied with this super 🔥 tweet, so I forgive her for participating in this onion of wrong).

Again, at face value, this makes no sense. If you choose to generalize the 2 hedge funds to hedge-funds-as-a-class and then reduce Wall Street to hedge-funds-as-a-class, you should believe that Wall Street has already lost since the 2 hedge funds were already forced to close out their short positions at a loss on Wednesday, the day before trading restrictions went into effect.

A more straightforward explanation is that the DTCC upped collateral requirements from discount brokerages and Robinhood didn't have the money. It's clear that Robinhood was short some capital for something since it drew down some of its credit lines (borrowed pre-approved credit from banks) and raised $1 billion from investors. Most likely, this is for the trades that had already gone through but hadn't settled.

Citadel is front-running Robinhood trades

People have historically been... concerned that Robinhood sells its order flow to dealers who can theoretically front-run RH's customers' trades. After Citadel (the hedge fund part, not the market-maker/dealer part) bought a non-controlling stake in Melvin, these... concerns have been repeated. AOC even got on Twitch.tv to interview someone who... posited this theory.

This is, foremost, a weird thing to bring up right now. I don't see what has changed to make the claims of front-running more legitimate than they were before. Trading volume on GME is up and Citadel (the market-maker) is making plenty of money and not being run over. It's not clear to me how Citadel benefits from front-running these trades in particular. It didn't need information about Robinhood trades to know about Melvin's losses.

Secondarily (and it's pretty weird that this is somehow secondary), there is just no evidence that this is happening. Occasionally, people will cite the SEC's Dec 17 fine, but purveyors of the narrative suddenly get ambiguous about what shady, evil things RH was doing. What was it doing? From 2015 to 2018,

Robinhood did not include payment for order flow as a revenue source in its answer to the "How Robinhood Makes Money" FAQ on its website.

and

Robinhood falsely claimed in a website FAQ between October 2018 and June 2019 that its execution quality matched or beat that of its competitors. The order finds that Robinhood provided inferior trade prices that in aggregate deprived customers of $34.1 million even after taking into account the savings from not paying a commission.

So it didn't disclose the payment for order flow from 2015 to 2018 and it didn't give customers as good execution (low bid-ask spreads) as its competitors from 2018 to 2019. There is nothing in here about its dealers front-running trades in 2021.

Other thoughts

Daytrading is a zero-sum game. Traditionally, the losers are retail investors. To quote patio11,

"retail investors destroy value when trading" is about as citation-needed as "smoking causes lung cancer" at this point

Of course, if retail investors believed this, they wouldn't lose money daytrading. Therefore, a narrative needs to be spun to explain how this time, it will be different. The signs don't point to anything special here other than the narrative being amplified online more quickly than before.