Over the last few weeks we have seen the Reddit phenomenon take over the headlines and to some extent take over complete segments of the stock market. In today’s landscape, it’s no surprise that the idea of group sharing ideas has finally reached the trading world.
For those of you that are new to Reddit the whole concept is to share opinions, thoughts, ideas in a group format for all to see. If you do a simple Google search for Reddit you will see that their tagline is they are “The Front Page Of The Internet” which could actually be expanded to say they are “The Front Page Of The Stock Market” based on what we have seen recently. People that had no interest in trading stocks just a few weeks ago are now glued to every price movement back and forth throughout the trading day.
Just over the last 2 days I have heard from family members that I haven’t talked to in months and friends that I haven’t talked to in years who are all asking about trading Gamestop stock. Retail traders are opening trading accounts at a record pace and interest in the financial markets has hit an all time high.
While the last few weeks has been fascinating to watch, has the Reddit movement changed the trading landscape forever? Let’s take a look at how the last few weeks have changed trading for all of us and how we should adjust going forward.
We have seen stretches going back in time where the popularity in financial markets has exploded. If you go back to the tech bubble in the late 90’s and early 2000’s we saw retail traders jumping into markets with both feet. We saw the housing bubble back in ’08 when everyone was focused on buying and flipping homes leading to instant riches for many people.
What did these periods have in common? They both eventually led to big financial crashes. While I’m not saying a market crash is imminent, it’s crucial to recognize that in the near term there is a clear warning signal flashing for all to see. In most cases, the mania stage occurs near the tail end of a movement. When retail traders start trading with extreme leverage like we are seeing now, you know the boat is completed loaded on one side. This can quickly lead to a market reversal which we need to be on the look out for.
Reddit Traders Unite
Whether you agree with the premise behind the Reddit movement or not, the bottom line is we are seeing how retail traders joining forces can have a huge impact on the way stocks trade. These new traders have united in the ‘wallstreetbets’ Reddit group that has dominated the news. Some of these new retail traders are in it just to make a quick buck and others are in it to try and stick it to the big hedge funds accused of rigging markets in their favor.
The Covid-19 pandemic has only heightened this movement because many people are out of work looking for ways to make an extra buck. More people are stuck at home with more time to pay attention to the news cycles on social media so it’s easy to get sucked into a new movement. This can lead to the extreme moves in stocks like we have seen over the last few weeks.
We are also seeing a whole new wave of younger traders that are getting involved in the markets for the first time as a result of the wild moves over the last few weeks in stocks like Gamestop and AMC Entertainment. We are hearing stories of young YOLO retail traders using their parents mortgage money to trade these Reddit stocks. Not something you see at market bottoms.
The last few weeks are a perfect example of how important it is to be open to new ideas as traders. We have to stay nimble as markets will change over time. We are in a shift now where the retail trader has to be respected. Am I saying we should all start trading based off info on Reddit? No absolutely not. However, we have to recognize that trends can develop for a variety of reasons and can lead to historic price movement. Managing risk is more important now than it ever has been.
While the amounts of risk being taken right now by these newer traders is alarming in many cases, I look at the growing popularity in trading as a great thing long term. We now have a new generation of traders getting attracted to the markets. As many of us know, once you get involved in the markets it’s hard to step away. These newer retail traders are now hooked for life. This is only going to help with liquidity in all markets which is a great thing for new and older traders alike.
The average daily trading volume in equities was 7 billion shares in 2019. That number grew to just under 11 billion shares in 2020. So far to start 2021 the average daily volume has skyrocketed to just under 15 billion shares. That is a huge spike in volume! Just in January alone trading volumes are up 92%.
Average Daily Equity Trading Volume
- 2019–7 billion shares
- 2020–11 billion shares
- 2021 15 billion shares
The big volume makes life easier for all traders. While we might not be able to maintain the January numbers long term, we believe the volume numbers will stay very active long term which is a welcome trend.
We will all benefit from the added interest in the markets. It’s just important to not get carried away in the manic moves that we are currently seeing in individual stocks thinking these extreme price movements are the new normal. Stocks like Gamestop moving 100% on a daily basis are not normal and we can’t expect these moves to last forever.
While the excitement in markets has grabbed the attention of the world the last few weeks, it hasn’t come without controversy. Just this past week we saw many brokers restrict the trading on these Reddit stocks to closing transactions only. Robinhood was at the center of this movement last week as they cut off the ability to buy any stock on stocks like Gamestop and AMC. The trouble with this move was that it completely shuts down free markets.
Robinhood is a newer broker over the last number of years that was founded on the idea that they were the broker that would fight for the small retail trader. They offer commission free trades. They have tried to cater to the on-the-go trader wanted to trade from a mobile app. The trouble with this is we all know nothing is free in this world. There is always a cost of doing business.
Robinhood made their money through payment for order flow. Essentially what this means is market makers pay brokers like Robinhood to execute customer trades. For example, a market making firm like Citadel pays Robinhood a fee to execute their customers trades. This can lead to large profits for the brokers. However, as we saw last week it can also lead to a conflict of interest.
It was rumored that Robinhood limited trading on some of the most active stocks at the request of a few large hedge funds that were in trouble due to to the large price swings in Gamestop and AMC. This is a huge conflict as it completely takes away the idea of free markets. This only fueled the fire that has been started by Reddit traders looking to punish the big hedge funds that run Wall St.
The huge volumes and volatile trading last week also put a strain on brokers market wide. Most brokers ran into issues with their platforms going down due to the wild trading that we were seeing. In some cases, traders were locked out of their accounts for hours. Not a good situation when you have hard earned money in trades with volatility exploding.
While we could discuss the broker dilemma from last week in more detail, the take away here is to be careful with your broker selection. Make sure you are trading with a broker that is well capitalized, has reliable software that won’t crash in volatile markets, and that are committed to protecting the individual trader instead of selling them out to the big institutions.
Our preferred broker is TastyWorks and they didn’t run into a single issue last week. They have a great platform with low commission rates as well. I tell our traders all the time to be open to using different brokers. Don’t get locked into one broker regardless of how long you have been with them. If we can get a more stable platform or lower commissions by making a change, it is well worth the time and effort.
We also recommend using multiple brokers if possible. This way if one of your brokers does run into an issue you aren’t locked out of your ability to trade and mange your risk.
While the new found interest in the markets is great for all traders, the last few weeks have highlighted the importance of risk management. What we thought to be impossible has been proven possible with the moves that we have seen. If you told me a month ago that stocks like Gamestop and AMC could move 200% in a matter of hours I would have told you that was crazy talk. However, we are seeing how anything is possible in this new age of trading.
The troubling part of the last few weeks for me as an instructor is seeing the amount of risk being taken. So many traders are throwing everything they have into trading without any concern for the risk involved. When markets get active like we have seen the last few weeks, it’s easy to get caught up in the excitement and trade too big out of the fear of missing out.
In reality, the best approach right now is to trade small. We recommend keeping the risk to 2–5% of your account per trade. Taking this approach will still give you a nice profit potential but will do so in a much safer way. It’s easy to look at a 200% move in Gamestop and think about the massive profit potential behind a move like that. However, keep in mind stocks don’t always move higher. We will see big moves lower as well. If you get caught on the wrong side of a big move it can get painful in a hurry.
We prefer that traders take a larger number of small trades. Spread the risk across 5–10 stocks instead of focusing in on the 1–2 stocks that happen to be in the headlines at the moment. The diversification that you can get from taking a larger number of small trades will lead to far better consistency over time.
Don’t Forget About These Stocks…
It’s easy to get caught up in the hype that surrounds the Reddit stocks. Who wants to trade Apple and Facebook anymore when Gamestop and AMC are moving 100% in a matter of minutes?
As we mentioned earlier, the moves that we are seeing over the last few weeks are not typical. We will see markets settle down. When that happens, it’s crucial to make sure you are trading stocks that have a track record of good movement.
Stocks like Apple and Facebook won’t move 100% in a day, but they have an established track record over years of good movement. They are very liquid stocks with big volume on a daily basis. They are going to provide a more stable trading vehicle that can still produce a big return on your investment.
I have been tracking Gamestop over the last week and in my opinion it is a very difficult stock to trade at this point. It moves so quickly and markets are so wide on the stock and options that it is difficult to get filled quickly and at good pricing. I’m not saying you shouldn’t trade the stock, but if you do just use very small risk and make sure you are picky with your order pricing.
Our trading has been great the last month in so many areas of the market. Don’t lose sight of the markets that have been active for years. There are so many great stocks and ETF’s to trade that will produce great returns in a safer way. You will be far better off long term if you learn how to diversify through different products while keeping the risk small.
We are all seeing a transformational shift in the trading world in front of our very eyes. This can provide great opportunities for active traders as long as we don’t lose sight of the big picture. We have to temper expectations knowing that the movement ins stocks like Gamestop and AMC are not sustainable. You don’t want to build your business around trading those stocks exclusively.
Instead, you will be far better off focusing on trading a diversified risk of stocks and ETF’s in different sectors while keeping risk management at the forefront of you trading. Making sure you are trading with an established, well capitalized broker is crucial as we all navigate these volatile markets.
There is a huge opportunity in front of all of us. The next few years are going to provide ideal markets for active traders. The Reddit traders have changed the trading landscape forever and that might just be a good thing.