Inside the mind of a GameStop investor

Users on Reddit's WallStreetBets page are throwing their money at maligned stocks like GameStop and Blackberry, partly out of spite against hedge funds betting against the firms.

The rush represents some troubling psychological dynamics among investors, with many caught up in a herd mentality that could see them left massively out of pocket, or even pursued by regulators, when the party ends. 

"Events like this resemble riot dynamics, where one is more likely to take a risky action — such as joining a mob or crowd like those on Reddit — if she or he sees that many others have already joined," Chengwei Liu, associate professor of Behavioral Science at ESMT Berlin, told DW. 

The mob mentality creates an illusion of size and power in the minds of participants, while allowing the individuals to underestimate the consequences of being caught out. 

"The dynamics of social media increase the power of this illusion," Liu said. "And because the investing is entirely online, the 'revolt' becomes self-fulfilling."

Redditors in a frenzy

Redditors have whipped each other up into a frenzy, aided by the mechanics of the site itself. The social media platform allows users to upvote and downvote each others' posts. On WallStreetBets, heretics are shot down while big winners get pride of place at the top of the page. 

Visitors to WallStreetBets are treated to incredible success stories from users like DeepF**kingValue, who bet $53,000 (€44,000) on a rising GameStop stock price back in summer 2019. DFV's investment is now worth $47 million, according to an investment account screenshot the user posted on Reddit.

The mixture of frenetic energy given off by WSB users, encouraging each other to "BUY BUY BUY!" and "Hold the Line" on specific stocks, plus the outrageous success stories, contribute to the mob mentality.

Part of the trigger for piling into GameStop was a report by Citron Research, which claimed that, at $40 dollars, the company was massively overpriced. Citron bet on the price of the stock going down, known as short selling. But by making a big bet against the beloved brand, Citron drew the ire of Redditors, who snapped up GameStop shares in retaliation. When the stock price rises, short-sellers can find themselves holding the can for a dud investment, piling up their costs. 

Giving the traders a specific target helped with the rapid formulation of the "mob," giving them enormous momentum, with short-sellers as the villains that the "rioters" are raging against. After all, many short-selling hedge funds have been accused of predatory practices, including so-called short-and-distort strategies, where they bet against the stock of a particularly vulnerable company while attempting to spread pessimism about the business and profiting from the fall in share price. 

"When you look at hedge funds getting caught out short-selling by a buyer, it's sort of poetic justice," Michael Hewson, chief market analyst at brokerage CMC Markets, told DW.

"It highlights the risks that arise from short selling. What you saw here was some very smart retail traders saw an opportunity and took full advantage."

Redditors can rationalize their motives but that does not make them immune from falling for the psychological traps that can affect all investors. Professional traders are taught to look out for the warning signs. 

How psychology affects investing

There's the phenomenon of sunk cost fallacy where investors continue to pursue a loss-making course because they already committed a significant amount of money to it

"Loss aversion and the sunk cost fallacy tend to make small losses become major ones," said Liu. 

On the surface, WallStreetBets investors appear to be well aware that what they are doing is risky but they feel more psychologically insulated against the fear of risk, as they see others investing. They are, like social media mobs of all kinds, enchanted by algorithms which fuel conformity. 

"We overreact to the virtual world the algorithms are feeding us," Liu continued. "In the real world it's hard to efficiently control which people or views we encounter."

"Social media algorithms control which views we encounter to make us feel good. Humans like to see their own view being endorsed." 

Legal consequences?

Individual investors could leave the battle far more bruised than the short-sellers. The highly risky bets on borrowed money could wipe out their life savings. They could even face serious legal consequences from the US Securities and Exchange Commission, should the SEC rule the Reddit group as a conspiracy to manipulate the market. 

"I have some concerns, certainly in terms of regulation," said Hewson. "You've had a whole host of retail traders get together on forums to try and manipulate or drive this stock price higher."

"Now, if you had institutions do that, you'd have the regulator coming down on them like a ton of bricks. My worry is that in the aftermath of all this, some inexperienced retail traders could actually get caught out in the backdraft."

In their attempt to take down their target, WallStreetBets investors are forgetting the psychological lessons learned by traders over decades. And how do riots come to an end? 

"Usually, someone gets hurt," Liu warned.