Reddit day traders are taking on hedge-fund giants and winning, and it's a sign of a new era for markets

• The 4 million-strong Wall Street Bets forum on Reddit has officially disrupted Wall Street.
• The Redditors did it by piling into heavily shorted stocks, sparking short-squeezes at the expense of Wall Street hedge funds and large institutional investors.
• Retail investors "are proving to be quite capable of mounting some successful 'value capture' against Wall Street institutional investors," Fundstrat's Tom Lee said.
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Wall Street hedge funds are scrambling, and it's all because of an online investing forum with more than 4 million members who describe themselves as "degenerates."

Reddit's Wall Street Bets forum has surged in popularity as retail investors in the group staged a gravity-defying short-squeeze in GameStop at the expense of hedge funds betting that the video-game retailer was on its last legs.

A short-squeeze occurs when investors who are betting against the stock are forced to close out their position by buying the stock, adding fuel to the fire.

As of Thursday morning, GameStop had a year-to-date gain of more than 2,400%. The rally in GameStop crushed Melvin Capital, a roughly $12 billion hedge fund that has suffered a more than 30% decline largely due to its short position in GameStop.

The hedge fund received an emergency $2.8 billion investment from Steve Cohen's Point72 and Ken Griffin's Citadel amid the record surge in GameStop.

Read more: As Redditors flood the stock market, UBS breaks down 6 options strategies investors can use right now to protect their portfolios

Citron's Andrew Left, a famed short-seller, also felt the heat from Reddit investors after he predicted last week that the stock would fall by 50%. Left ultimately closed out his short in GameStop for a loss, as did Melvin Capital.

Maplelane Capital, another New York hedge fund, also faced a decline of about 30%, The Wall Street Journal reported.

The developments are remarkable when you consider that retail investors on Reddit likely lack the sophisticated data feeds that multibillion-dollar hedge funds rely on.

But after spending a few hours on the forum, the billionaire investor Chamath Palihapitiya concluded that the Reddit traders could do the same fundamental analysis as hedge funds, and possibly do it better than them. Palihapitiya followed the retail investors into GameStop and won big.

Now Reddit traders are trying to replicate the success of GameStop and targeting other stocks that are highly shorted by professional investors. And they're succeeding.

Stocks like AMC Entertainment, Bed Bath & Beyond, and Virgin Galactic have soared this week as Reddit investors piled into the names via both stocks and deep-out-of-the-money call options, creating unprecedented demand for the shares.

Read more: A chief investment strategist breaks down how the GameStop saga could upend decades-long practices on Wall Street - and shares her 4-part advice for navigating the frenzied trading environment

Retail investors "are proving to be quite capable of mounting some successful 'value capture' against Wall Street institutional investors," Fundstrat's Tom Lee said in a note on Monday, adding that "large size does not always win."

But Wall Street Bets' influence on stock moves could wane as systematic funds "adjust" their models to incorporate this new source of volatility, Lee said.

It's not only quant funds that could put a dent in the influence of 4 million Reddit traders - it's also trading platforms.

On Thursday, Robinhood restricted buy trades in a handful of stocks that had seen epic short-squeezes and had been targeted by the Reddit group, including GameStop, AMC, and Nokia.

Now, according to Lee, the question is: "Will their strategies endure?"

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