Social media discussions fueled ‘meme stock’ events and significant short squeezes, research finds

LAWRENCE — In January 2021, the “meme stock” GameStop (GME) saw a surge driven by the Reddit community. This sparked massive short squeezes that caused hedge funds to lose billions when the stock went from $17 to $483 in less than a month.

“An event like this clearly showcases how a large mass of small traders with little to no market impact can actually have a significant market impact,” said Angel Tengulov, assistant professor of finance at the University of Kansas.

His new article titled “Squeezing Shorts Through Social Media Platforms” examines how meme stocks (those that surge due to social media hype rather than financial fundamentals) such as GME and AMC experienced sudden price increases, which, coupled with high short interest, led to short squeezes in January 2021. The research finds that discussions on social media fueled the association between retail trading and subsequent stock returns, which significantly impeded market quality for the stocks and their competitors.

The article appears in Management Science.

A “short squeeze” happens in the market when investors bet against a stock that aggressively increases in price, causing these short sellers to cut losses and exit their positions, he said. 

“This is a very interesting set of events because it is so different from historical short squeeze events,” Tengulov said.

What makes the incident so different is it was triggered by the coordinated efforts of small investors. Short squeezes initiated by large or more sophisticated market participants have been studied in the past. But the impact of retail trader coordination through social media platforms remains largely unexplored.

“However, as we saw in 2021, if they coordinate through social media, their trading can lead to market-distorting events such as short squeezes,” he said.

Co-written by Franklin Allen of Imperial College London, Eric Nowak and Matteo Pirovano of Università della Svizzera Italiana, Switzerland, and independent scholar Marlene Haas, the research argues these events were fueled by trader migration into options markets and short covering by short sellers which, ultimately, led to the deterioration in market quality.

“Up until then, people did not believe social media could act as a device that helps small investors coordinate their trading strategies. But this is exactly what we saw back then, and this has happened over and over since then,” Tengulov said.

To study this event, he and his team obtained social media activity data of the meme stocks by algorithmically scraping all user posts and comments that mentioned these tickers from January through February 2021. This included the platforms Reddit, Twitter (now X) and StockTwits.

“We show that social media activity rapidly increased during the days of these price increases. And we were interested in the social media chatter. How do retail traders and investors communicate over the social media platforms? While reviewing a lot of posts and comments on the platforms, we found they were basically encouraging each other to buy and hold meme stocks and initiate a short squeeze,” he said.

Was one particular social media outlet more influential than the others?

Tengulov said, “Even though that was not the primary focus of the paper, we have evidence StockTwits and Twitter — now X — were slightly more influential,” he said. “But Reddit also contributed to these dynamics.”

Actions intended to cause short squeezes are technically illegal in the U.S.

“What social media platforms have done to make sure what we observed in 2021 was not driven by illegal actions is they have started screening for bot activity. At the time, there were concerns that a lot of these messages were automatically created by computer programs. So social media platforms have implemented a lot of checks and balances to try and clean bot activity,” Tengulov said.

“Unfortunately, that’s also their business model. They cannot restrict free speech.”

A native of Bulgaria, Tengulov joined KU in 2021. His past articles on this subject include “Market Efficiency and Limits to Arbitrage: Evidence from the Volkswagen Short Squeeze” and “How Prevalent Are Short Squeezes? Evidence From the US and Europe.”

“We want to make the public aware of the power of retail trader coordination and stress the point that these traders are not unsophisticated anymore,” Tengulov said. “Because through social media platforms, they can become sophisticated and have a market impact that is very similar to the impact of large institutional traders.”