David, let’s start with what actually happened to GameStop?
It’s hard to do this without feeling like Margot Robbie in that bath scene from The Big Short!
To understand what happened with GameStop, you need to understand what a ‘short’ is in trading terms. A ‘short’ is when you borrow shares in a company from a broker and sell them immediately at their current price. Then you hope the share price falls, so you can buy the shares back at a lower price, leaving you to return the shares you borrowed to the broker – while pocketing the difference. The big risk of shorting is that if prices rise, buying the shares back becomes expensive, meaning you could lose a lot of money.
In the case of GameStop, a popular forum on Reddit noticed that a hedge fund called Melvin Capital had taken a large short position in GameStop. This hedge fund had bet that the price of GameStop shares was going to fall and, when it did, the fund would make a nice profit. However, those who saw what was going on convinced a group of fellow Redditors to join forces and buy GameStop shares. This, of course, sent the price skywards – at its peak, GameStop shares were up 2,000% – and the hedge fund’s position started to become a serious liability. Eventually, the hedge fund had to close its position and re-purchase the shares at a much higher price, sending the stock even higher. This is what’s known as a ‘short squeeze’. Melvin Capital is reported to have lost around $3.75bn on the trade.
Why did this happen?
Overnight, the fundamentals of GameStop as a business had not changed. The company remains the same company it was before, during and after this episode. This was simply an opportunity for a group of people to come together and wave a collective middle finger at Wall Street, banks and large financial institutions.
Why did it happen now?
In part, that’s a question for a sociologist rather than a wealth manager! However, since the 2008 financial crisis, many view Wall Street as a greedy goliath putting profits above everything (see, for example, Industry on BBC). Therefore the chance to bloody Wall Street’s nose I am sure feels like a moral victory for many. In terms of why it happened now, I think the advent of self-trading, with platforms such as Robinhood in the US becoming more mainstream, was certainly a contributory factor. This has made trading for yourself much easier than it was previously. Furthermore, social media has clearly made sharing information both quicker and easier.
Will the Redditors all have made a lot of money?
Now that the frenzy appears to be over and GameStop’s price has dropped from its peak, as with all short-term bets, there will have been winners and losers. Early adopters who bought at low prices will likely have made a lot of money. Those who invested later in the cycle are likely to have lost money.
We’ve already seen smaller frenzies around silver, American Airlines and AMC Entertainment… Is there anything to stop this happening again and again?
Right now, no. However, as the GameStop situation progressed, it caught the eyes of the regulator, which was looking at suspected market manipulation, and the newly appointed US treasury secretary Janet Yellen. Until they make any moves, I would speculate there will be plenty who try and use social media to replicate GameStop. Whether it will happen again to the same degree is difficult to say.
Could the same thing happen to UK stocks?
In theory, there is no reason this could not happen in the UK or to shares traded on UK markets. However, we have to remember this started on a Reddit thread in the backwaters of the internet well before it became mainstream. What makes any story become viral? It’s a combination of many factors including novelty – which certainly seems to have impacted the popularity of GameStop’s stock. But, even if the novelty’s worn off, the mechanism theoretically exists for this happen in the UK.
Are regulators likely to react eventually?
The role of a regulator is to protect retail investors, so I would imagine it is something they will seek to explore. On the institutional side, could we see changes to the rules in short selling? I think that is more difficult to speculate on, but my hunch is that very little will change.
How is Wall Street likely to react?
Wall Street will continue to do what Wall Street does. I do not think this will impact them.
What are the real-world consequences of these trading frenzies?
Stories such as these rarely have any sort of happy ending for the majority. Other than the handful of investors who might sell at the right time, the only real beneficiaries of this are the brokers and early adopters. The individuals who see this trending on Twitter or TikTok or Instagram and buy in for that reason are likely going to get burnt.
Where do you generally stand on self-trading platforms like Robinhood
Self-trading platforms have a part to play in the democratisation of investing. As such, I think they are a net positive. However, they are very much open to the intention of the individual user and how they are using it. In some cases, ‘speculation’ is just a fancy word for gambling, and my view on investing is that it should be very different to gambling.
If they are dabbling in self-trading platforms, what should private investors beware of?
We've all heard stories about the grandfather who bought a share of Apple stock in the 1980s and is now a multimillionaire. But what about everyone else who bought shares in some other company and isn’t now a multimillionaire? The problem with identifying a single investment that's going to make money over the next few days/weeks/months/years/decades is that no one has a crystal ball. Sure, Apple now looks like a smart investment, but even this apocryphal grandfather is likely to have invested in things that caused losses as well.
In the wake of the GameStop story, is there anything else investors should be doing to protect themselves?
Investors can get anxious about missing out on what they perceive as a great investment. They may follow the crowd. News and financial commentary can influence people’s view of investing. Without a strong investment philosophy to guide them, they may also follow the advice of friends, neighbours or family, especially if the ‘insight’ promises a fast, easy return.
Warren Buffett’s mentor Benjamin Graham said: “In the short term the market is a voting machine and in the long term a weighing machine”. In other words, sentiment will often drive the stock market in the short term, but fundamentals will win the day over the long term.
So-called ‘meme stocks’ like GameStop are not investing. They are gambling. When you decide to gamble, my guidance will always be only stake what you are willing to lose. And remember: investment markets can remain irrational longer than you can remain solvent! While stories like GameStop are fun to watch, for serious investors there is no substitute for personalised, long-term guidance.
My guidance to anyone who is relatively new to investing is that investments should be made over the long term with specific goals. This way, you can ensure that it is tax optimised, while also taking the level of risk that is appropriate to achieve your goals. In short, before you start trading on any platform, you should look to understand ‘why’ you are making the investment to better inform ‘what’ the investment should be.
David is an associate director on the financial planning team at Buzzacott. To find out more, head to Buzzacott.co.uk
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