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GameStop logo is seen near displayed stock graph in this illustration taken on Feb. 2, 2021.DADO RUVIC/Reuters

Legions of new investors are diving into stocks amid speculative surges in a handful of popular names and a relentless rise in the broader market.

Will these investors wind up as stock-market roadkill, or a force to be reckoned with for years to come?

Online brokerages, some offering free stock and option trades, are reporting a surge in new accounts and an explosion of trading activity. These new investors have quickly changed the way the investing game is played, forcing long-time market professionals to take notice.

GameStop Corp. shares on the New York Stock Exchange surged as high as US$483 in late January, notching a gain of 2,700 per cent since the start of the year amid a flood of emoji-laden cheering on Reddit. The buying frenzy triggered big losses for short-sellers, largely market pros who bet against companies they see as overvalued. But GameStop shares have since collapsed way back to US$63.77, delivering painful losses for anyone who bought into the upward ride.

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The GameStop action illustrates how small investors can win big by scoring gains at the expense of savvy hedge funds. But it also shows many were simply chasing the latest hot investment, which was inevitably going to return to earth as the mania subsided.

“What we’re seeing now is a lot of novice, very green investors, people who have ridden the hype,” said Anita Lo, vice-president of the Canadian operations of Dalbar Inc., which evaluates discount brokerages. As part of its work, Dalbar gained access to many conversations between investors and brokerages’ customer service representatives. That gave the firm a close-up look at misunderstandings that befuddle many new investors, including lack of knowledge about margin accounts (which use borrowed money to invest) and when to take profits by selling a stock.

“The interest and the curiosity level, that’s always a good thing. You have more players in the market. But you need more informed players,” Ms. Lo said.

Industry data point to an influx of individual investors into the market on a scale not seen since the dot-com bubble more than two decades ago. The COVID-19 pandemic is partly behind the rush. It has allowed young, green investors time to get into the game, while economic uncertainty and government stimulus money have driven up savings rates and given individuals firepower to buy stocks.

In the first three quarters of 2020, Canadian investors opened 2.5 times more accounts with online brokerages than in the same period of 2019, according to a report by the consulting firm Investor Economics. More recently, the brokerage industry is reporting an even more dramatic increase in growth, driven by younger, more active traders focused on the market’s hottest stocks.

“Things have escalated to a whole new level,” said Christine Zalzal, head of Qtrade Investor and VirtualWealth. “January was our biggest month on record for everything we measure.”

Traditionally, the typical discount brokerage customer has been in his or her mid-50s. But in the first week of February, the average age of Qtrade’s new clients was just 35.

Meanwhile, the handful of most-traded stocks on the platform would normally account for around 1 per cent of total volume, Ms. Zalzal said. This past week, though, there were days when more than half of Qtrade’s volume was centred in just two stocks – GameStop and AMC Entertainment Holdings.

“As more retail money comes in and starts to compete with institutional money, then I think for sure you’re going to see more turnover in underlying portfolios, which causes more trading activity and volatility,” Gajan Kulasingam, a portfolio manager at Toronto-based Goodwood Inc.

“There is a paradigm shift here where more and more investors are just going to come into the market, because it is so accessible,” he added.

Having witnessed the power of the retail investing community to drive monumental stock swings, Wall Street is now scrambling to get visibility into online market forums and message boards, to track shifts in attitudes as they’re happening.

This past week, data provider Thinknum launched a Reddit Mentions dataset, which, for close to US$25,000 a year, gives clients the ability to track the tickers attracting the most attention on investing-themed subreddits such as WallStreetBets, which powered the rise of GameStop and other stocks. Thinknum promotes the product as an “insurance policy” for institutional investors to “protect themselves from Reddit.”

While sentiment-data products scraped from social media have been around for several years, there is a new urgency to getting a finger on the pulse of the rank and file.

“There’s tremendous insights that you can take from the crowd,” said Jamie Wise, the founder of Toronto-based Buzz Indexes. Buzz built a portfolio that uses stock discussion on sites such as StockTwits and Twitter to gauge sentiment toward U.S. large-cap names. The portfolio of 75 names outperformed the S&P 500 last year by about 40 percentage points, Mr. Wise said.

The surge in retail has some long-time market pros on the run. Short-sellers – investors who bet against stocks by borrowing shares and then selling them, hoping to buy them back at a lower price and pocket the gains – are now thinking again about these high-risk trades.

Even before the Reddit hordes mobilized against what they perceived as predatory short-sellers, many hedge funds had already been backing away from shorting stocks. That’s because over the past five years, the bull run in stocks has gathered steam, creating a market-wide upswell that can be dangerous to bet against. Over that time, the average stock in the S&P 500 index has nearly doubled.

“With the activity we’ve seen in the last month, I would need to see all of this clear out before I went back to shorting individual stocks,” said Brandon Osten, chief executive officer of Toronto-based hedge fund Venator Capital Management. “There’s just not enough money to be made for the headache you’re going to have to endure.”

Much of the Reddit narrative is that small investors are levelling the playing field. But the democratization of the stock market has been going on for decades – for example, through the rise of exchange-traded funds, which have offered investors a cheap and accessible way to track baskets of stocks. Since the performance of ETFs essentially matches major benchmarks such as the S&P 500 and the S&P/TSX Composite Index, small investors can compete effectively against just about anyone.

Many in the latest crop of new investors are bound to eventually learn the ropes of investing rationally and embrace sensible long-term strategies such as broad-based ETFs.

Discount brokerages are starting to catch up with the influx of new investors. “I think once everything settles, there’s going to be a lot more guidance and hand-holding,” said Dalbar’s Ms. Lo. And when the broader market next runs into a big dip, that guidance is sure to impose additional rationality among investors. “No one is thinking about that right now, because every news outlet, every article is talking about GameStop,” she noted.

True, many individual investors have long been tagged with an undeserved reputation as uninformed.

“Most people look at retail as not sophisticated and not intelligent,” Mr. Wise said. “There’s a lot more intelligence in that community than it is historically been given credit for.”

Even so, some professional money managers say the latest rush into hot stocks is not a triumph of small investors over the pros.

“I don’t for a minute believe that this is a philosophical battle to democratize retail investing. It’s just pure greed,” said Stephen Takacsy, CEO at Montreal-based Lester Asset Management.

“Unfortunately, it’s sucking in a lot of unsophisticated investors who are going to end up losing a lot of money. It’s going to end in tears for most,” Mr. Takacsy said.

And some professionals have been basking in extraordinary gains that challenge the storyline of Main Street success. Most notably, Senvest Management LLC rode the rise of GameStop from lows below US$10 per share in September to last month’s highs above US$400, delivering a realized profit of about US$700-million, according the The Wall Street Journal.

Professionals such as Mr. Kulasingam also see an upside in trading against inexperienced investors who might not appreciate his focus on value.

“There’s nothing to be nervous about, unless volatility makes you nervous,” Mr. Kulasingam said. “The higher level of continued volatility in the market gives me an opportunity.” It’s easier for him to sell a stock if the price has enjoyed a tremendous run-up, or buy more shares of a company that has fallen by the wayside even though the fundamental argument for owning the stock stands up.

Mr. Takacsy has his own success story. He sold his shares in BlackBerry after seeing Reddit-fuelled investors run the price from below US$8 a share in mid-January (in New York) to intraday highs that topped out above US$28 – well above what the money manager considered fair value.

“It’s a great exit strategy for guys like us. We’ll take the money and run,” Mr. Takacsy said.

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