Retail traders have demonstrated how much they can influence a stock. In early January of 2021 the now famous subreddit WallStreetBets caused a massive short squeeze of GameStop stock. Within two weeks GameStop went from a price point of $20 to a huge $500 before crashing down to the mid $100’s.
This huge spike in volatility and price caused some hedge funds to see massive losses on their short position. One of the hedge funds that shorted GameStop, Melvin Capital. saw a 51% loss on their entire portfolio because of Reddit and WallStreetBets. (Source)
Ever since then every hedge fund has started watching online chat forums, websites, and social media to see what retail traders are doing. As we speak, funds are creating advanced trading algorithms that will auto trade for them based solely around online chat rooms such as WallStreetBets. (Source)
Hedge Funds routinely monitor online stock chat rooms to gauge how likely individual retail investors will trade a stock. They do this by creating algorithms that web scrape data from chat rooms and then assign a retail investor sentiment score.
This article is going to show you how hedge funds use famous internet chat rooms such as WallStreetBets to make huge returns. By arming yourself with this knowledge you will understand how to do the same thing. At the very least you will see the signs of a stock about to explode.
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Without wasting any more time, let’s hope right into the article: How Hedge Funds Use WallStreetBets to Make Huge Returns.
What Is A Stock Algorithm?
A stock algorithm is simply a computer program that collects and manipulates data to give an investor/fund a better understanding of what is going on.
A stock algorithm can be extremely basic. An example of this would be a computer program that simply looks for a stock that fills certain variables. These variables can be volume, volatility, liquidity, price, and many more.
Further, a stock algorithm can be extremely complex. These algorithms import outside data and combine it with readily available market data. Examples of these algorithms would incorporate satellite imagery, environmental data, government documents, or audio transcribed files.
In reality so long as a computer can interact with a data set you can build an algorithm around it. For the purposes of this article we are only going to be looking at one advanced data set. Web Scraped data on social media sites populated by retail traders discussing stocks.
What Is WebScrapped Data?
What if I told you that you can download an entire website and have a computer go through it to find certain words? Let’s say that you downloaded WallStreetBets and had a computer find how many times an individual stock was mentioned.
That is web scraping data. You are scraping public data off a website to analyze.
Ever since the late 90’s the power of retail traders to impact the markets has become larger. Now in the early 2020’s retail traders are directing and controlling the entire market. This is terrifying to hedge funds who use their outdated investment methodologies and risk models to ‘predict’ the market. (Here is an article going over the rise of retail traders since 2012)
This year stands as a watershed mark for retail traders. Now retail traders understand the power they have in the market and have started to band together to manipulate the market in their favor. They gather in web forums, chat rooms, and on social media to discuss their ideas.
That is why web scraping data has become so important to hedge funds. They can better predict where retail investors will go next. The good news is that you can use this data to make massive returns without even knowing how to code.
How Hedge Funds Use Web Scraped Data To Create Stock Algorithms
Ok, what we are about to discuss is very new to the ‘professional’ investing world.
When a hedge fund has a computer comb through the huge data set they get back from web scraping they assign values to each word. What this creates is semantic linking words that create high value sentences.
For those who have a hard time conceptualizing this here is an entire academic article going over how powerful sentiment analysis, semantic linking words, and value assigning is to investing. (Source)
Simply put, hedge funds scrape wallstreetbets for everything written on the subreddit. Then the fund will build an algorithm that goes through the huge data set to assign values to certain stocks. The stocks with the highest values demonstrate exactly what wallstreetbets is currently talking about. This in turn gives a hedge a leg up on a normal retail trader because they can ‘visualize’ everything going on.
Popular Free Web Scrapped WallStreetBets Tools For You To Use To Make Massive Returns
Currently there are two free web scrapped tools on the market. These tools are not as complex as the ones created by large hedge funds but they will help you conceptualize everything.
These tools will give you a leg up on other traders/investors. They do nearly the same thing that hedge funds do. There are some variables that both of the above tools miss out on. That being said, they give retail investors a taste of what algorithmic trading is like. Furthermore, they are extremely easy to use.
Once you have experimented with those tools then we can move on to how you can incorporate this knowledge for yourself.
How You Can Make Massive Returns Doing The Same Thing As Funds
You need to remember two words; “Sentiment Analysis.” In order to do this properly we need to discuss three steps to mimicking how hedge funds trade or sentiment analysis of wallstreetbets.
The first step is going to be discussing the theory behind the position/trade. Second, is discussing how we are going to place the trade/position. In the third step I am going to show you when you should.
Step 1: Theory Behind Why Sentiment Analysis Works
That is what we are doing here. We are looking for large amounts of retail traders who are all looking at the same couple of stocks to gauge overall retail trader market sentiment towards a stock. When enough retail traders focus on one or two stocks then volatility will increase as they either buy or sell.
We can make money off this volatility increase. So long as we know that more and more retail traders will be trading (buying/selling) on a stock then we can position an investment to make money.
This is why sentiment analysis of chatrooms such as WallStreetBets is so important. We can figure out retail trader sentiment towards a stock before the market trades it.
As we can see from the above graph as more and more retail traders/investors begin to look at a stock then the ‘swings’ that the stock sees in price increase. This is because there are only so many shares that can be bought and sold on a stock. If more and more retail investors/traders are looking at a stock then we will see wider price swings.
Here we are looking at the law of supply and demand. As more and more investors want to buy a stock that was mentioned on WallStreetBets the trading volume increases. This increase in trading volume will lead to a spike in volatility, which will drive the price up. Once this happens retail investors/traders will start buying more and more shares which will drive up the price even more.
Whenever a stock’s price moves you can make money. All we need to do is monitor the sites/chatrooms where retail investors hang out in (such as WallStreetBets).
Here we need to monitor social media to find out what stocks are gaining in popularity. The next step is to take out a position that will benefit off only increasing volatility and not price movement. There is a trade out there where you only make money if volatility in a stock increases, regardless of which way the price moves.
This type of trade is called the Iron Condor.
Step 2: Placing the ‘Iron Condor’ Trade To Profit Off Increased Volatility
The Iron Condor Trade simply tells the market “I bet that this stock is going to either decrease or increase in price rapidly.” You don’t know which way it is going to go, you only know that it is going to move either up or down.
We know that this will happen because of sentiment analysis showing an increase in volatility on a stock. As more and more retail traders pour into a stock the price will shoot up or down. As such we will make money either way the stock moves.
Here is a graph demonstrating what the Iron Condor trade looks like.
As we can see we create a ‘zone’ for the iron condor trade. For the above graph this ‘zone’ is between the price points of $130 and $70. If the stock ever moves outside that range during the duration of the contract we will make money. It does not matter which way the stock goes, either up or down. This is because we already assume that one ‘wing’ of our iron condor is going to lose. The other wing will make up for the lost wing and then make a profit.
If you want an entire run down on the iron condor I wrote an entire article on the trade that goes into depth on how it works. (You can find it by clicking here)
Step 3: When You Should Use This Type of Investing Strategy
The secret here is waiting. You need to use sentiment analysis on WallStreetBets (or any other social media) to show a stock growing in retail investor/trader attention. Once you see that you need to mimic what the hedge funds are doing by executing iron condor trades before the retail trader crowd starts pouring in.
This is the secret, you need to watch WallStreetBets and figure out what is going on before you execute this trade. When done properly however you can rest easy that it does not matter which way the stock swings you will make money.
That’s how hedge funds use WallStreetBets to make huge returns. They simply just bet that volatility is going to increase on a stock and then take a directionless bet.
The good news is that you can do this as well. Once you understand how everything works you can easily perform this trade over and over again. The secret however is following investor sentiment analysis. You need to be certain that retail investors will start pouring into a stock before you make this trade.
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Further, you can check out some of the other articles below.
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Until next time, I wish you the best of luck in your investing journey.