When you try to think of a hot growth stock that you think will deliver above-average returns over the long term, GameStop does NOT come to mind.
The outlook for the struggling video game retailer’s industry is not good when you realize that digital downloads are the preferred option for many gamers today, rather than going to physical stores and exchanging their completed games for dreary prices.
GameStop is basically what BlockBuster was to the video rental market and we all know how that ended.
Throw in a global pandemic where everyone is staying at home and you can see why the retailer has posted huge losses in recent years, including a whopping $725 million in 2019.
However, if I tell you that over the last month, the retailer’s share price has skyrocketed from $19 to over $400 you may think that they have turned things around and the stock market speculators had got it drastically wrong.
Well, the truth is the market didn’t get it wrong…but they got very greedy.
Are you surprised?
So what did happen? Did the billion-dollar hedge funds collude to drive the GameStop price lower than where it should be for their own financial gain? Perhaps.
Did they mislead the public and investors and use certain media channels to start false rumors about how bad things really are at GameStop? Maybe.
Did they underestimate the power of small investors on social media with an axe to grind? Definitely.
The Rise of The ‘Redditors’
We all know that to a certain extent, trading in the stock market is rigged in favor of the huge hedge funds that have the ability to trade at microseconds.
Their setup is so advanced that before you even open a link for a breaking news article, their trading algorithms have already acted on the news.
So, where does this leave the small-time investor? Well, the ‘Oracle of Omaha’, Warren Buffet, preaches long-term investing as the key to success and that it is at least a more even playing field when coming up against the like of Goldman Sachs and the big investment banks.
Does this mean you should you give up before you have even started – just buy an index fund and just leave it to compound over time? There is no right answer here.
Whilst over the long term your ‘buy and hold’ strategy will result in more spectacular returns, there is always an opportunity, even in the short term, in a marketplace where vast amounts of money exchange hands every day.
Enter Wall Street Bets. A group of ‘Redditors’ who scour the markets looking for bargains and mispriced stocks in order to exploit price discrepancies for profit. The group has been running for years and they are getting good at spotting an opportunity.
Brief History of Shorting
If you have seen the movie, The Big Short, you should know what short selling is unless Margot Robbie explaining financial terms to you in the bath had you distracted.
But without going into the finer details, short-selling gives speculators the ability to profit when a stock goes down. That’s right you can profit from a company’s demise.
Is this immoral? Who am I to judge…but yes it is immoral.
Traditional investing allows you to participate in the success of a company’s innovation and growth and is of benefit to the country’s economy. Short selling flips investing on its head and allows you to profit from the demise of a business.
That is not to say short selling is without risk, in fact it is a lot riskier than the simple ‘buy and hold’ strategy. If short selling goes wrong you could lose so much more than what you originally invested but with the ‘normal’ investing risk is limited to what you put into the company.
****Small Tangent**** Daniel Kahneman is a Nobel Prize-winning behavioral scientist who discovered that as human beings we tend to over-emphasize negative events than we do for positive outcomes. Applying his findings to finance, he found that bad news would impact a stock’s price much more heavily than the equivalent good news.
Short sellers act on this very principle and can start using dirty tactics such as starting false rumors about the performance of a company to hammer the share price.
Here Comes The Squeeze
Shorting stocks has gained a particularly bad reputation with the amateur investor as it represents all the bad things about the markets. To make shorting truly successful, you need to have the ability to borrow a large number of shares and influencer media outlets.
Only the elites have the ability to do this.
The guys and gals at WallStreetBets last month decided to teach the hedge funds not to get ‘cocky’ and arrogant about their ability to put a company out of business. The group had discovered that hedge fund companies like Melvin Capital had taken a huge short position in GameStop.
And when I say huge, I mean huge…over 100% of its available shares had been used to short the stock.
The online Reddit forum felt that this was market manipulation at its finest and the stock was over-shorted and worth a lot more.
******At this point, it’s worth remembering this isn’t just some game of cat and mouse, a company’s share price dictates their ability to raise funds on the open market. If some hedge fund has forced your share price through the floor, the company stands less of a chance to recover as its ability to acquire new funding is limited and thousands will lose their jobs.*******
Members of the online investing community started buying the stock through low-cost online trading platform, RobinHood (we will get to their role in this a bit later).
As the share price started to rise from all the forum members buying, the hedge funds started to lose money.
Now at this point given the fact that GameStop is struggling and has been severely impacted by Government lockdowns in the pandemic, the hedge funds knew something fishy was going on…so they weren’t too worried.
There is no way a group of social media addicts will cause them to lose money – right?!?
But it just kept going up and within a few days the price had skyrocketed to over $450 when it was just $19 a few days earlier.
How did it go up so quickly? It wasn’t all reddit buyers but they certainly lit the fuse.
By creating a buying frenzy and pushing the stock higher, whilst getting some help from one of the richest men in the world, Elon Musk’s Twitter account, the hedge funds were hemorrhaging money.
This is where their metal was really tested. Should the billion-dollar funds ride out the buying wave because it wouldn’t last or would they have to close out their positions and buy the stock back thus increasing the price even more to the Wall Street Bets advantage?
In the graph above you can see that at around $150, Melvin Capital broke their resolve and bought back all the shares it had shorted, doubling the value of the Wall Street Bets holdings overnight.
The glorious irony of these events is that usually it’s Wall Street who facilitates the transfer of wealth from the middle class to themselves but this is the first instance in years where huge amounts of wealth had been returned to the average investor.
Were the financial elites going to take this as a lesson and a warning not to get so cocky in future. Of course not and why would you when you can rig the game?
RobinHood – Steal From The Poor To Help The Rich?
Ye Olde England legend Robin Hood stole from the rich in order to give to the poor. He has gone down in history as an example that if your intentions are honorable then, in most scenarios, your actions can be justified.
It was on this very notion that the stock trading platform, RobinHood, operated – to finally give the average investor the ability to trade on stocks without all the big commissions and management fees that made it so much harder to compete with the professionals.
Finally, the little guy was being given a chance (or at least that is what they marketed).
But whilst they were promoting this ‘David vs Goliath’ message behind the scenes a very different story was being told. The company were selling information about their user base to the highest bidding multi-billion dollar hedge funds, for use in their own algorithms…ouch!
So when GameStop started to crush these hedge funds (RobinHood’s backdoor customers) many users may have thought that the brokerage company would be cheering on Wall Street Bets and their actions.
I mean that’s how they even market their platform right?
Well, it turns out that RobinHood are ‘sort of’ on the side of the average investor. Within days RobinHood suspended trading in GameStop in order to alleviate some of the pressure on the big investment banks and hedge funds. They would only allow sell orders and not any buy orders – which obviously would only serve to help the institution’s money.
Of course the company gave out the usual spiel of ‘liquidity issues’ and ‘over-leveraged positions,’ but ultimately, the game was up for Wall Street Bets.
****IMPORTANT LESSONS*** If you make money at the expense of large financial institutions … you won’t be able to trade. If a large financial firm says its on your side…they are lying.
How is this any different from a casino? At least before they chuck you out for winning too much, you get some free drinks and maybe even a free room for the night so you can keep playing the next day, giving you enough time to lose your money.
At RobinHood they just stop you playing.
In fact, Wall Street Bets members have been banned from Discord and they are now a highly targeted forum by regulators who are debating whether to go after them for market manipulation.
That’s right in this scenario its the small-time online investors who are going to be investigated.
If you don’t laugh, you will cry.
What is the Solution?
Ten years ago the answer to this scenario would have been to create a commission-free online trading platform designed specifically for retail investors.
Well, RobinHood has put that idea to bed.
The only thing you can do in the short term is use a trading strategy that accepts the markets are rigged for the big players and that will always be the case.
But this story is not all over just yet…there are some legal challenges in the works (how many times have we heard that recently) and maybe it will serve as the changing of the tides. I won’t hold my breath.