The Reddit Rebellion: What to Expect
The battle between Wall Street and Main Street and the psychology behind it.
Posted January 31, 2021
Wall Street's elite went on a roller coaster ride in a seemingly unfamiliar theme park operated by millennial/Gen Z-packed Reddit forums this week. It appears that hedge funds that typically prosper on market volatility were left with little more than white knuckles and motion sickness by Friday's market close. The question remains: How could amateur day-traders upend a tried and true, fundamental short-seller strategy? Social psychology may be the key to answering the question. First, read the twists and turns of the timeline in case you are new to the amusement park.
Social psychology is the study of how other people influence our thoughts, feelings, and actions. These influences are so deeply ingrained in who we are that they are difficult to recognize. Author Derek Sivers' analogy can illustrate the influence best: "Fish don't know they're in water. If you tried to explain it, they'd say, 'Water? What's water?' They're so surrounded by it that it's impossible to see. They can't see it until they jump outside of it." Could these subtle influences be fueling forums and contributing to the current chaos in the stock exchange? You be the judge.
Conformity: Power in Numbers
Social influence is defined as the influence of others on our attitudes, opinions, and behaviors. Social influence can take many forms, including conformity. Conformity is defined as aligning one's attitude, opinion, or behavior to those of others. It describes how we adjust our behavior or thinking to follow the group's behavior or rules. According to the Washington Post, there were nearly 6.3 million members of the finance subreddit /r/wallstreetbets forum on Reddit as of Friday. In one night, membership increased by 1.5 million. Imagine the confidence felt knowing that you and a 6.5-million-man army are figuratively and literally rallying for the same cause?
Why Do We Conform?
In 1951 Psychologist Solomon Asch conducted a simple "line judgment task" to determine the extent to which group pressure changes people's beliefs, attitudes, and opinions. Asch measured the number of times each participant conformed to the majority view and ignored reality. On average, about 32% of the participants went along and conformed with the trials' incorrect majority. Over 12 trials, about 75% of participants conformed at least once.
- Informational Social Influence. They may believe the group is better informed than they are. Reddit is a space where people congregate for advice. It's considered a discussion website. If seemingly well-informed peers are making thousands of dollars with posted receipts as proof, would you heed their advice?
- Reference Groups. Reference groups provide the benchmarks and contrast needed for social comparison and evaluation of group and personal characteristics. We conform because we want to bear a strong likeness to those we admire. For example, if Elon Musk is my personal role model and he tweets, "Here come the shorty apologists, give them no respect, get shorty," well then, I'm going to get shorty and shorty gets no respect while I'm at it.
Herd Mentality: Following the Flock or Cooperative Power?
We are social creatures who often gain information from the behavior of our fellow species. Keynes regarded herding as a response to uncertainty and individuals' perceptions of their ignorance. Herd mentality is a well-documented phenomenon responsible for stock market bubbles, financial speculation, mob violence, political choice, and consumer preferences. The pack mentality causes us to adopt certain behaviors based on emotion rather than logic. Just picture "Black Friday" madness only on a digital platform. However, herd mentality is not always a bad thing. Michael Bond, author of The Power of Others: Peer Pressure, Groupthink, and How the People Around Us Shape Everything We Do, provided an example of the history-changing cooperative power of the Egyptian revolution in 2011, which led to the resignation of Hosni Mubarak. In the end, Tony Tran may have the most sensible advice, "If you do find yourself in the midst of a herd, keep in mind BOTH the dangers and benefits of herd mentality." And remember that Warren Buffett quote: "Be fearful when others are greedy and greedy when others are fearful."
Groupthink: Dangerous Investing Decisions
The theory of groupthink was first developed by the social psychologist Irving Janis. Groupthink is defined as "concurrence seeking." Janis states groupthink becomes so governing in a unified group that it tends to override realistic assessment of alternative courses of action in order to maintain consensus. Janis purports that groupthink reduces how effective groups will be at solving problems. Embedded in the group is an emphatic "we-feeling." A quick perusal of the wallstreetbets forum will present gifs, memes, and captions which read "We like the stock, GME to the Moon," and "We will not stop, occupy GameStop." The "we" in each of these posts is crucial to understanding groupthink. "We" suggests an "us against them" mentality. You are a part of the "club," or you are not, and every decision made within the group will aim to maintain this solidarity. Often, members of the group will remain silent against their better judgment to not jeopardize the "clubby" feeling. When you are monetarily incentivized to ignore possible problems coming down the pike, the outcome is rarely positive.
Wallstreetbets Members: You May Win the Battle, But You Could Lose the War
Symptoms of groupthink include the "Illusion of Invulnerability." Inherent to groupthink is the feeling of "specialness" or immunity. The fantasy of the entire group coming out unscathed and victorious is just that, a fantasy. In June 2020, Alexander E. Kearns, a 20-year-old student at the University of Nebraska, took his own life after seeing a $730,000 negative balance after trading options on the Robinhood app.
It's essential to break away from the media hype, take a step back and determine if you are making the best decision for yourself and your mental health. Are you financially capable of sustaining a potential loss? Did you leverage too much? Are you proficient enough in day trading to understand all of the alternative possibilities and unexpected twists? For example, did you ever consider that your trading platform would be inaccessible and restrict transactions like it did on Thursday? Were you comforted by the class action lawsuits against Robinhood? Don't be. Think back to the Wells Fargo account fraud scandal of 2016. They just reached a settlement in 2020 for violating antifraud rules. Yes, illuminating unfairness and bias is essential to inciting long overdue change, but in the interim, can you endure the damage to your wallet?
The irony of a trading platform called Robinhood allegedly stealing from the poor to give to the rich, is not lost on me. Political scientist James Fowler at the University of California, San Diego, fashioned a creative behavioral economics study that demonstrated real egalitarian impulses in human nature. Participants in the game consistently spent their own money to take from the "rich" and give back to the "poorest" of players. Subjects who had received more than the group average were penalized most frequently and most heavily. Hence the "Robinhood Impulse" was born. Players expressed the greatest frustration and anger levels in a hypothetical situation where one player got far more than they had. The players who felt the strongest spent more to equalize the distribution. Sound familiar?
"If people didn't have a taste for equality, then I would expect the world would be even more unequal than it is," he said. "It has not been fully appreciated yet how much people are willing to level the playing field and how much this determines our ability to cooperate with each other. The 'Robin Hood impulse' people display in the lab," Fowler said, "appears to translate into good citizenship out in the world."
What We Can Predict About the Saga's Ending
With a plethora of deeply ingrained social influences and the outrage of members of Congress like Alexandria Ocasio-Cortez, and celebrities Marc Cuban, Jon Stewart, and Barstool Sport's Dave Portnoy, it looks like hedge funds and short-sellers should buckle up for a bumpy ride. This rebellion has all the inner workings of a financial revolution. In the words of Fredrick Douglas, "the thing worse than rebellion is the thing that causes rebellion." Word of advice to Wall Street and Main Street: It might behoove everyone to brush up on some social psych.
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