GameStop, Reddit & Wall Street
Are you out of breath trying to keep up with the breaking news about GameStop and all the other red-hot trades o’ the day? Here’s a synopsis (to date), and what it means to you as an investor.
Seemingly Unstoppable Games
Last week, a perfect storm of traders converged on the market, propelling the prices of a few previously sleepy stocks into the stratosphere. Jason Zweig of The Wall Street Journal reported, “From Jan. 25 through Jan. 29, a ragtag army of individuals sent shares in GameStop Corp. up 500%, and sent many others skyrocketing too.”
Reddit Gone Wild
Interestingly, there was no huge, breaking news or major shift in these companies’ fundamentals to explain the surge. Instead, a tidal wave of trading momentum happened to form on a Reddit forum called WallStreetBets.
Keith Gill (aka, Roaring Kitty)
If the GameStop movement had a leader – or at least a cheerleader – it might have been Gill, who had been entertaining his online friends with GameStock status reports since he began trading it in spring 1999. The Wall Street Journal reported, “Mr. Gill said he wasn’t a rabble-rouser.” But, the report continued, “Many online investors say his advocacy helped turn them into a force powerful enough to cause big losses for established hedge funds.”
Big Short-Sellers Get Squeezed
Whatever inspired the movement, it soon became a force of its own, like an online flash mob buying and holding shares at increasingly higher prices. Why would anyone do this? Some may have just gotten caught up in the excitement. Even Elon Musk got in on the action with his “Gamestonk!!” WallStreetBets tweet. Others were hoping to profit on a communal squeeze play against “fat cat” hedge funds and others who had chosen to short-sell the same stocks.
When a trader short-sells a stock, they’re betting the price is about to drop. If it does, they can profit handsomely. But if the price instead shoots upward, a short-seller can face a margin call, requiring them to cough up the difference between the original share value and the fast-soaring price. In the case of GameStop, short-sellers like Melvin Capital Management lost billions of dollars meeting margin calls, which in turn became chum to the feeding frenzy.
As the frenzy continued, many retail trading platforms – including Robinhood, Schwab, TD Ameritrade, and others – started experiencing trading overloads. Technical glitches, as well as deliberate trading restrictions, ensued. Not surprisingly, traders impacted by the lapses and restrictions have cried foul, perhaps rightfully so.
Enter the Fed
Is the phenomenon just a new, but legal variation on a very old market mania theme? Did anyone actually violate existing regulations, and if so, whom? Are new regulations warranted? Securities regulators are considering these questions, not yet resolved.
Now, to the main point. Where does this leave YOU as an investor?
You may have noticed: As we’ve introduced the players in this unfolding drama, we’ve not used the term “investor.” That’s because none of them are, in fact, investing. Not the retail traders flexing their communal muscle. Not the short-sellers who lost their shirts. Not the trading platforms, stuck in the middle.
Everything we’ve been describing so far has involved trading, where there’s nothing new about having big winners and sore losers. By definition, trading is a messy, cut-throat, zero-sum game. For every trader who gets to buy low and sell high, there must be a pair of traders on the other side, who were willing to sell low and buy high. The only real questions in the current drama are whether any rules were broken that made the trades illegal, or whether any new rules need to be crafted to ensure markets don’t become so unstable, they cease to operate.
This is a perfect example of the risks in taking a short position in an equity and it is likely the hedge funds and other institutional investors that are running into significant trouble had these short positions that comprised a large fraction of the allocation/risk budget of their portfolios and are now paying a heavy price. This is a situation of poor risk management by the hedge funds and/or they just got greedy and went overboard shorting the stock.
As proponents of relatively efficient markets, we remain confident these questions will be resolved. It may not be pretty, but this too shall pass.