In my last post, I wrote about the GameStop short squeeze, the allure of Wall Street Bets, and how the theory of reflexivity can teach us about the broader societal implications of the trading frenzy. Two weeks later, the party is over and (once again) retail investors got the short end of the stick.
Small investors were inveigled into a trade where they lost their shirts and some big players and market makers made out like bandits. For about two days, buying GameStop stock was a “movement”. That is, until it became clear that the market is brutally efficient and doesn’t care about populist rhetoric. At that point, the GameStop trade turned into a game of “who is holding the bag”. When your investment thesis depends on the assumption that the mainstream media is outright lying to you and that massive fraud exists in the market, it’s time to get out.1
How did this happen? I’m not going to go into a play-by-play of what happened – enough has been said about this.2 Rather, I’ll use GameStop as a case study for how reasonable, smart people get caught up in manias, cults, and mass movements.
Wall Street Bets is Dead…
…and we have killed her. A month ago, Wall Street Bets was a subreddit with some stupid memes and outlandish options bets, but also with people who actually knew something about finance LARPing as “retards”.3 There was solid due diligence: in-depth analysis of companies’ financial statements along with market sizing and strategic growth prospects. Some of the analysis wasn’t that much different from the first draft of an investment memo for a buy-side firm.4
As this Reddit comment states:
Redditors never seem to stop and think about why the WSB guys know so much about derivatives trading. Or how they seem to know how to access and read from a Bloomberg terminal. Or why there are so many users there that can seemingly drop tens or hundreds of thousands of dollars on complicated meme plays.
How do you think that WSB knew that GME was open to a short squeeze and a gamma squeeze play?
WSB’s power users are younger finance bros. It’s 30-something investment bankers and portfolio managers memeing with each other and cosplaying as “autists.”
If you didn’t know what a gamma squeeze was 48 hours ago, you are their exit strategy and the down payment on their next Porsche.
When the subreddit was a fringe group of people who actually knew something about finance, there was alpha to be found in its insights. Wall Street Bets was about getting some laughs in the pursuit of fuck-you money. However, over the past few weeks, Wall Street Bets was flooded with newcomers (it quadrupled in size over the course of about a week) who, along with the mainstream media, turned the GameStop trade into a “movement” and “taking on the hedge funds”.
In retrospect, this was the writing on the wall:5
Gamestonk!! https://t.co/RZtkDzAewJ— Elon Musk (@elonmusk) January 26, 2021
We Are All Monkeys
Let’s revisit a classic psychology experiment, which apparently never happened. Nevertheless, it is a good allegory for the GameStop trade (and the business world in general).
A scientist places five monkeys in a locked room. Inside the room, there is a ladder with a bunch of bananas at its top. Each time a monkey climbs the ladder to try to reach the bananas, the scientist pulls him down and sprays him – as well as all of the other monkeys in the room – with a stream of cold water.
After this cycle repeated a few times, the monkeys learn that climbing the ladder leads to a faceful of cold water. So, each time that a monkey begins to climb the ladder, the other monkeys in the room pull him down so they can avoid being sprayed.
The scientist removes one of the original monkeys from the room. The monkeys’ self-policing continues. When the new monkey tries to climb the ladder, the others pull him down. The new monkey learns that he shouldn’t climb the ladder.
Here’s the kicker: The scientist replaces all of the monkeys in the room, one by one. By the end of the experiment, none of the original monkeys (the ones that had been sprayed with cold water) are left in the room. But all of the new monkeys continue to pull down any monkey that climbs the ladder, without knowing why they are doing it.
Now we modify this experiment slightly. Rather than replacing the monkeys in the room, the scientist simply adds new monkeys. But midway through the experiment, the power goes out! The scientist can’t see any monkeys climbing the ladder. The original monkeys realize that this is their opportunity – they scramble up the ladder and eat all of the bananas. By the time the power comes back on, the new monkeys continue to pull one another down from the ladder and are left diamond-handing (💎 🤲) banana peels.
Cults Are Fun
It’s fun to be one of the monkeys in this room. You’re among a group of people who are excited about something; they have some special knowledge that promises to make them fabulously wealthy. Their knowledge is doubted by the mainstream, but their prophecies keep coming true.
They have a special language that distinguishes them from the outgroup. You are welcomed as a part of the tribe, you start to lose yourself in the fantasy of becoming rich and become swept up in the mob, experiencing a bit of the loss of self that comes from being a part of a mass movement.
There is a huge sense of urgency. You can get in on this thing, but only if you act now. Your heart beats a little bit faster – that’s FOMO. You’re experiencing optimism bias – because you understand what is happening, this is bound to work out for you.
All you need to do is buy in and hold on. Anyone who defects from the party line is subject to ad hominem attacks. They are relegated to the outgroup.
The goalposts keep moving. Every time a price target is reached, the ceiling is raised. $100 is not a meme. $420.69 is not a meme. $1,000 is not a meme. $10,000 is not a meme!
The mainstream media is not to be trusted. They weren’t on your side to begin with – why would they be now? There is a disinformation campaign going on – your group has been infiltrated. You don’t know who and what to trust, so you need to stop thinking for yourself and have blind faith in the process. Groupthink abounds.
Retail investors are selling more than they’re buying? That data is suspect. You choose to ignore information from sources that you previously considered valid because this doesn’t fit the narrative (fallacy) that you and the others have created.
As you begin to lose money (or unrealized gains) on your position, you dig in deeper. You become anchored to the gains that you were already counting in your head. You won’t settle for anything less! You’d never buy in at these levels, but what you already have? Of course you let it ride – the endowment effect in action. You fall for the sunk cost fallacy and throw good money after bad to double down on your position.
It’s hard to exit the echo chamber. You don’t want to admit to yourself that you were taken for a ride; that you only have yourself to blame for the losses you endured. You want to keep believing. The ending to the story is so much better if you keep believing.
Originally I included this gif simply because it was funny, but in writing this essay, I realized that it’s actually quite apt. The people who got in and out of this trade early made a boatload. The followers had a lot of fun (for a while), got caught up in the mania, and lost money.
We all want to belong to something greater than ourselves. Smart people are no different – they are drawn to cults all of the time.
Look at the annual mass exodus from San Francisco to Black Rock City to celebrate Burning Man. Or Silicon Valley executives who wear Vipassana retreats6 as a badge of honor. The best startup cultures are often described as “cult-like”. You either fully buy into the mission or you’re out. Think Uber and its “you eat what you kill” attitude (at least until Travis left), or Roam Research, which fully embraces the #roamcult hashtag and even has a compound in Utah.
Cult Vibes (image via The Information)
Zooming out a bit, SoulCycle and other premium fitness classes are both:
- A signal of wealth and
- Cult-like in their intensity, adherence to strict guidelines, and hero worship of individual instructors.
Even mainstream (i.e., moderate) organized religion is simply a cult that has stopped taking itself so seriously.7 Moving to extremist religion, terrorists are relatively wealthy and well-educated. They disproportionately hold engineering degrees. Scott Alexander makes the compelling argument that this can, at least partially, be attributed to epistemic learned helplessness, the idea that sometimes the most rational thing that someone can do is to ignore an argument that they can’t refute.
[A] sufficiently smart engineer has never been burned by arguments above his skill level before, has never had any reason to develop epistemic learned helplessness. If Osama comes up to him with a really good argument for terrorism, he thinks “Oh, there’s a good argument for terrorism. I guess I should become a terrorist,” as opposed to “Arguments? You can prove anything with arguments. I’ll just stay right here and not blow myself up.”
So perhaps epistemic learned helplessness (or rather, lack thereof) can help explain why smart people can be so drawn to scams, cults, and mass movements. When one is used to seeing the world in a way that others don’t – and, quite frankly, feeling intellectually superior to others – it is easy to lose the humility and self-doubt that would have helped during the GameStop scenario. Being intellectually aware of the cognitive biases that we face as human beings is different from (and even perhaps inversely correlated to) the ability to step back and say, “This is crazy, I’m out.”8
Cults aren’t inherently a bad thing.9 Just know when you’re in one and have an exit strategy for when it’s time to leave.
Lessons are for sale every day.— Dan Reardon 👽 (@danieljreardon) February 3, 2021
Hindsight is 20/20…I was also guilty of this. In my last post, I wrote about ridiculous memes causing people to storm the Capitol, then got caught in an echo chamber and became a QAnon-esque believer in the Mother of All Short Squeezes (#MOASS). I was so laser focused on seeing the stock price go even higher that I couldn’t see the real squeeze taking place in front of my own eyes. I held a few positions for too long and watched unrealized gains evaporate from my account. I learned an expensive lesson – something I already knew intellectually, but now also feel. (But don’t feel too bad for me, overall I made money in this whole imbroglio.) ↩
Given the strong language, perhaps a little bit closer to a few buy-side analysts discussing opportunities over drinks. ↩
Caveat emptor. Those who piled into the chatter about this trade (Elon, Chamath, Mark Cuban) fomented the speculative fervor while either:
- Not holding positions or
- Being smart enough to get out of the trade while it was on the upswing.
I went on a Vipassana retreat in 2017…I have some notes from the experience that will be the subject of a future blog post. Spoilers: I left early. Incredibly powerful experience. Incredibly cult-like experience. ↩
Many cult-like companies (Apple, Tesla, etc.) push the world forward in leaps and bounds. ↩