I am sure by now everyone has seen or heard about the GameStop Mania. GameStop is a video game retailer that operates mostly in malls and the stock has been going up hundreds of percent a day. To understand what’s going on, let’s take a step back.
Jason Zweig described investing in his book “Your Money and Your Brain” as follows: “Stocks have prices; businesses have values. In the short run, a stocks’ price will change whenever someone wants to buy or sell it and whenever something happens that seems like news. Sometimes the news is nothing short of ridiculous. He continued later… In the long run a stock has no life of its own; it is only an exchangeable piece of an underlying business. If that business becomes more profitable over the long term, it will become more valuable, and the price will go up in turn. It’s not uncommon for a stock’s price to change as often as a thousand times in a single trading day, but in the world of real commerce, the value of a business hardly changes at all on any given day. Business value changes over time, not all the time. Stocks are like weather, altering almost continuously and without warning; businesses are like climate, changing much more gradually and predictably. In the short run, it’s the weather that gets our notice and appears to determine the environment, but in the long run it’s the climate that really counts.”
Most of us know when buying a stock, you are considered “long” the stock. If it goes up, you make money.
Investors also have the ability to “short” a stock This means the investor will make money if the stock goes down.
If you are long a stock, you can only lose your initial investment if the stock goes to $0.00. If you are short a stock, your potential losses are unlimited because a stock can continue to keep going up.
Back to GameStop.
Hedge funds and institutional investors have been shorting GameStop. They felt like it was a dying business and that the company and stock would continue to go down, which has been largely true as shown below:
The company is not doing well. However, as these things usually go, hedge funds took it too far and shorted the entire company. More than 100% of the shares outstanding were being sold short. Investors, dominated by hedge funds, were basically saying GameStop is going out of business.
As I mentioned previously, in the short run fundamentals of the company don’t matter, supply and demand do. Some tech-savvy investors participating in the online message board Reddit and Wall Street Bets tried to figure out what the hedge funds were doing. They decided together to orchestrate one of the biggest short squeezes of all time. A short squeeze is when a stock jumps sharply higher, forcing traders who had bet that its price would fall, to buy it in order to prevent even greater losses. Their scramble to buy only adds to the upward pressure on the stocks’ price.
That is what has been happening with GameStop and AMC Theatres and BlackBerry. Investors aren’t betting on GameStop to become a great company, but they did take advantage of short-term structural inefficiencies in the market.
A lot has been publicized by the media. The retail investor “little guy” sticking it to “the man” meaning the hedge funds.
Is this just a bunch of kids online trying to get rich quick?
Are younger people just outsmarting older people?
Has the rise of free trading and technology changed the market?
The answer as always is probably somewhere in between all of these possibilities. We have seen things like this before with online message boards and dot com mania. I am not making a direct comparison, but this isn’t completely new and there will be retail investors who will lose a lot of money. However, many investors have made a lot of money throughout this mania as well.
Over time, the market will adapt as it always does. Highly volatile stocks like GameStop and their option prices will rise to combat the short squeeze, as we have seen; and hopefully, hedge funds have learned a lesson about shorting more than 100% of companies’ outstanding shares.
As always, we will evaluate market moves, stay in our lane, and stick to our investment disciplines.
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