The Network Effect of the Stock Market.

Network Effects are powerful. I’ve written about them here, here, and here.

Right now, there is something historical happening in the stock market. A group of retail investors is pushing a stock up against hedge funds who had shorted the stock driving the GameStop company towards bankruptcy. If you’re not into stocks and haven’t heard about it, Google GameStop or GME stock chart and look at it’s multi-year chart, you’ll see something doesn’t look right. This event will no doubt be a lesson taught to finance majors about risk management in the future. It’s also a powerful look at network effects. Before we talk about that though, if you’re not familiar with investing you might ask, what is a hedge fund?

A defintion found online is: A hedge fund is a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains. Basically, they pool a bunch of money together from investors who might be lawyers, doctors, business owners, old money, and possibly roll in some bank loans, then they use that pool of capital to hire smart financial minds to make investments. For their efforts, the hedge fund takes a share of the profits, and returns most to the original investors pockets.

So what is a hedge fund really? It’s a network of money. And when networked together, that pool becomes much bigger, much more powerful and is able to manipulate things against smaller investors. What are some ways they can manipulate things?

  • Stock ratings,
  • tweets by people following these huge pools of money,
  • network shows having them on to share their feelings about which way the market is flowing,
  • and also they can use huge amounts of money to directly manipulate share prices by short selling to drive prices down, which they then buy up again and sell at higher prices.

It’s the huge backing of money that gives the hedge funds so much power to do things even a person with $100,000 or $1,000,000 to invest can’t dream of, let alone people with much smaller amounts than that. For decades, maybe centuries, these companies told the little guy, “You need to invest with us. Sure, we’re going to take fees, but you’ll be protected with us, against the other big players.” Doing so gained them clients, earned them fees that could have gone into a retail investor’s pocket, and kept the wheels turning for them making many of them very rich.

Then the internet happened. Then interactive trading platforms happened. Then commissions and fees started to disappear to stay competitive while social media grew. Then something magical happened, small investors started finding themselves communicating with other small investors. Their collective moves started to have power on the scale of hedge funds. After all, hedge funds are just a network of money. The only difference between a hedge fund and a huge collection of retail investors now is that the hedge funds collect salary for their work, and they have fewer management people making decisions.

It turns out that when normal people connect, share, and put their efforts towards the same goal, they are extremely powerful. Today, the stock market, at least the institutions that have represented it for decades, is learning how powerful a group of like-minded investors can be.

This isn’t limited to stocks. This is everywhere. Institutions are only institutions because people grant them, prestige, power or resources. The ability that exists today to connect with others is allowing everyone to remake the institutions that were previously untouchable or seemed to be something that couldn’t be replaced. Power is always in groups. If you aren’t connecting people, ask yourself, “Why not?”