The “Reddit" Effect: How Alternative Data Shakes Up Investment Markets

At least that’s how they are supposed to work. 

Some investors appear to no longer be interested in “investing” in a company. Quick profits through schemes like algorithmic trading and derivatives speculation have appeared to completely distort the market. Throw in central-bank quantitative easing that props up values and passive investing that tracks market-weighted indexes, and we have a recipe for a dysfunctional market where economic indicators and company performance no longer drive valuations in a meaningful way.

Savvy investors are turning to data for better returns

It’s not a secret that the ultimate goal for most investment professionals is to “beat the market” by generating greater than average returns. Thanks to the “casino”-like atmosphere of the markets these days, that’s harder than ever before.

Professional investing these days requires an increasingly sophisticated strategy based on specialised knowledge. And that knowledge comes from advanced public web scraping practices that produce “alternative” data - information that goes above and beyond market indicators to provide above-average insights for above-average returns.

What is investment alternative data?

To illustrate what alternative data is, let’s first clarify what it’s not. Alternative data is not regularly published in economic reports, investment news, press releases or corporate annual reports.

Alternative data comprises economic, financial and trending information published outside a company or government. That can include social media networks, websites and applications that provide critical information not found in traditional sources.

Examples of alternative data sources may include:

• News sentiment
• Short interest rates
• Third-party publicly available stock market forecasts
• Security ownership information
• Real estate market fluctuations and indications
• Building permits

Alternative data provides unique insights

Alternative data has a short history and tends to be used less commonly by market participants. That’s why it provides a much-needed edge to investors looking to outperform the market.

It’s also a big business: spending on alt data surpassed $1 billion by 2020 with more than 400 suppliers on the market.

As mentioned previously, there are various types of alternative data. Some are more economics-based, while others are purely speculative.

And that brings us to Reddit, and what is likely one of the largest short-selling fiascos in all of modern trading history.

The “Reddit” Effect, Gamestop, and the short-selling saga of 2020

Most people reading this are aware of the Gamestop short-selling debacle that took place in 2020. For those that aren’t, let’s take the story back to the beginning.

Video games are a big business, and the sales model changed drastically in the last decade. Back in 2009, 80% of games were sold in physical form. That number dropped to 17% by 2018 as game sales moved online.

Gamestop was one of those businesses going the way of video stores renting VHS cassettes and DVDs. A staple of discount strip malls, Gamestop was clearly on its way out.

Investors had that figured out long before the public took notice. They took action through derivatives-based speculation, called “short selling,” that lets them profit on the price of a dropping stock.

Short selling is complicated but to make a long story short, what you need to know is that if the price goes down, short-sellers win. If it goes up, they have to pay the difference - and that can have disastrous financial consequences.

And thanks to Reddit, it did.

How Reddit caused billion-dollar trading losses

Reddit is a social network. People congregate there to discuss topics from skydiving to workouts to knitting, and everything in between.

One group on the network, known as WallStreetBets, shares info and tips on trading. It had been growing in popularity as trading apps became common and had a sizable following by the time all this started.

WallStreetBets members took notice of short selling activity on Gamestop early on in September of 2020. One member created a post called Bankrupting Institutional Investors for Dummies. Shortly after that, members organised a mass movement to buy the stock in large numbers to push its price upward with the overall goal of getting back at institutional investors.

Remember earlier, when I mentioned that rising prices could lead to massive lost profits? Well, that’s precisely what happened. The price of GameStop rose from about $10 per share in September to a jaw-dropping high of $325 per share by January.

The result: an astonishing $19.75 billion loss for short-sellers by the end of January, according to S3 Partners, a firm that tracks US stock short positions.

Finding alternative data beyond Reddit

The Reddit/Gamestop saga brought the importance of alternative data front and centre. Companies can purchase data sets, subscribe to platforms that provide real-time data or scrape it themselves with in-house scraping solutions or outsourced ready-to-use tools.

The internet is a treasure trove of data that can give investors those key insights needed to find stock market gems. Some examples of specific alternative data in the finance sector that may be useful include:

• Politician trading activity
• Government contracts
• Product recalls
• Twitter activity
• Reddit forums (like WallStreetBets)
• CEO compensation
• Work visas
• Corporate flights

Modern investment strategies require alternative data 

Whether you participated or not, the Reddit saga likely affected how you perceive, assess and participate in the stock market. While time-tested and true investment principles are still needed long-term, alternative data can help give you the edge needed to make above-average returns on stocks traded today and in the future.