GAMESTOP AND THE RISE OF RETAIL TRADING.

• Author: Schulp, Jennifer J.

In January 2021, a curious event in the stock market caught the attention of the media, regulators, and the public. A well-known struggling company dominated the headlines, not for its business model, but for the meteoric rise of its stock price. GameStop Corp. started the year trading around $19.00 a share, a pretty robust share price for a company that had been trading below $5.00 as recently as August 2020. Yet, by the end of January, GameStop's shares were trading at over $300, at one point hitting a high of $483. GameStop's stock price has receded from those meteoric highs, but, as of late May, it continues to trade between $160 and $180 a share.

Experts--and a significant number of nonexperts-raced to explain what happened. The media, at least, settled on a David and Goliath narrative, pitting a band of individual traders against Wall Street hedge funds that were betting against GameStop's success. The fact that many of these retail traders utilized a brokerage app named Robinhood only added to the narrative.

Mechanically, the rapid and dramatic rise in the stock's price was partly attributable to a "short squeeze" initiated by increased demand by retail traders who largely organized through the Reddit forum WallStreetBets. The rising stock price led some holding short positions, including certain prominent hedge funds, to buy the stock to limit their losses, which put further upward pressure on the stock's price. A similar feedback loop attributable to options purchases also propelled the stock price. And strong demand for the stock was bolstered by the attention that die media showered on the phenomenon, pushing the stock even higher.

Easily compared to a law school issue-spotter exam question, or perhaps a Rorschach test, the GameStop phenomenon has raised questions and concerns regarding equity markets from just about every angle imaginable. Politicians from both parties found reasons for outrage, including the rare (and brief) unification of Rep. Alexandria Ocasio-Cortez (D-NY) with Sen. Ted Cruz (R-TX) in ire against Robinhood Financial's decision to restrict its users from opening new positions in GameStop at the height of the frenzy.

The incident has spawned three hearings by the House Financial Services Committee; one hearing by the Senate Banking Committee; one meeting of the heads of the Treasury Department, Securities and Exchange Commission (SEC), the Federal Reserve Board of Governors, and others; and a host of investigations by the SEC, Financial Industry Regulatory Authority (FINRA), and state securities regulators covering market manipulation, short selling, and other issues. The SEC is also preparing a request for public comment on dre "gamification" of securities trading, considering recommendations about further disclosure on short selling, looking closely at the structure of equity markets, and drafting a proposal for shortening the equity settlement cycle (Gensler 2021).

One thread that runs through all of these inquiries is the protection of retail investors--the same retail investors who appear to have initiated the GameStop phenomenon in the first place. While it is hardly surprising that some individual investors lost money on trades they made--just as it is hardly surprising that some individual investors made money on their trades-the investor protection impulse of some legislators and regulators tends to overlook two key concepts: (1) the GameStop phenomenon is an example of retail investor strength, not a demonstration of weakness; and (2) increasing retail participation in equity markets should be encouraged, not restricted by burdensome regulation.

Retail investors are important and beneficial participants in equity markets, and recent innovations in the ways retail investors can access markets have brought more--and more diverse--investors into the fold. While an interesting event for any number of reasons, the GameStop phenomenon is not a sign that the markets are somehow broken or that more regulations are needed to protect investors. Ultimately, any regulatory response must be careful not to undo the benefits of wider retail participation in equity markets by introducing, or reintroducing, barriers to retail investor participation.

Retail Participation Is Good for Equity Markets and Investors

At the outset, it is important to recognize that participation by retail investors in equity markets is beneficial to both the markets and investors. There is little academic consensus about the wholesale effect retail investors have on equity markets (Eaton et al. 2021; Friedman and Zeng 2021), but the lack of consensus is not surprising, in part, because retail investors themselves are a heterogenous bunch, varying in their levels of diligence, appetite for risk, and motivations. The fact that retail investors behave differently from institutional ones, and sometimes behave differently from each other, can be particularly valuable in times of market stress. Where institutional liquidity dries up, for example, retail trading can help to lower bid-ask spreads and dampen the price impact of trades (Ozik, Sadka, and Shen 2020).

In fact, retail investors may have been a market-stabilizing force during the March 2020 coronavirus-induced market crash by staying the course with their investments and buying when stock prices dipped dipped (Ozik, Sadka, and Shen 2020; Welch 2020). This type of behavior appears to have continued throughout the pandemic, with individual investors tending to buy more shares when the market was down 1 percent than when it was up by the same amount (Banerji 2021).

The maxim "more is better"-while not foolproof-generally applies when talking about participants in the stock market. Despite the derogatory nature of terms used for retail investors, including "dumb money," retail investors bring a lot to the table when investing. More investors mean more information, which benefits all market participants by helping to establish more efficient prices. More capital invested by those investors helps to fund the growth of the economy. And investors with greater risk tolerance, a feature often criticized when talking about retail investors, are necessary to fund the innovation and entrepreneurship to secure future economic growth (Coy 2021).

Finally, investing in the stock market is an important path to wealth for individual investors. While stocks do not always go up, the average annual return for the S&P 500 over the past 60 years has been approximately 8 percent (Maverick 2020). This type of return is for and away above returns of many other savings or investment vehicles available to individual investors, giving long-term investors good opportunities to grow wealth through equity investment.

Retail Investing Reached the Masses in 2020

Retail participation in equity markets had been growing for several years, but that trend accelerated sharply during tire pandemic. Approximately one-fifth of market trading volume was attributable to retail orders throughout 2020 and early 2021, a substantial increase over 2019 (Osipovich 2020; SIFMA 2021a). As 2021 has progressed, retail investor activity appears to be cooling somewhat, but it is expected to remain elevated above its prepandemic levels (McCabe 2021; SIFMA 2021a).

Most commentators pin tire recent increase in retail participation to the availability of so-called zero-commission trading, where investors do not pay an upfront commission to trade. (1) Although Robinhood Financial began offering zero-commission trading in 2015, the model spread like wildfire in late 2019, ultimately becoming an industry norm among app-based trading platforms and large discount brokerages. While zero-commission trading is a significant innovation, it is important to place it in historical context: brokerage fees have been declining for the past 45 years as a result of regulatory changes and competition (Mihrn 2020). In this way, zero-commission trading is simply a logical outgrowth of discount brokerages in the...