We’ve gotten a question or two about the GameStop stock trading frenzy of the last week or two. Luckily, not out of want or concern (we would never recommend speculative trading to anyone, frankly) but more out of wanting to understand what’s happening. So, here’s a quick explanation for what’s happening, and why it MAY be relevant moving forward.
First, it’s good to understand that there are power in the masses. Just like many other issues, debates, and movements of the last 12 months, social media yields a lot of power in quickly getting a message across and stirring up support (or anger). In this case, the masses attacked “the establishment.”
Everyday people (defined as “retail investors”) can pretty easily trade through online platforms (a popular one is called “Robinhood”). In fact, this type of platform targets a new generation of investors who take pride in actively managing their own money and making frequent trading decisions. A New York Times article from last year notes the average age of Robinhood subscribers is 31 and the frequency of trades being placed significantly outweighs other popular platforms like TD Ameritrade, E-Trade and Schwab1.
These traders banded together through Social Media discussion (namely an app called Reddit) to stick it to big hedge funds who were known to be trying to profit from certain companies’ demise. First, note that hedge funds are now seen as the “Wall Street Establishment” and the biggest fish in the financial universe. After big banks had to follow new speculative trading rules following the Great Recession of 2008, these hedge funds became the big players able to take the biggest risks, skirting past restrictions now placed on the banks. It’s fairly common practice for these hedge funds to “sell short” a company’s stock. The easiest way to describe “selling short” is to make a bet on the stock to go down, and when it does, you profit. So, if a hedge fund wanted to profit off of people NOT going to the movie theatre in the middle of a pandemic, it would sell short a company like AMC. The brick and mortar gaming store GameStop was on that list too. It felt immoral to kick a company while it’s down, and traders took action.
By banding together, traders talking together through an online forum like Reddit, all decided to place trades through platforms like Robinhood and started buying shares of these crumbling companies. More and more traders joined in and it snowballed in a big way over many days. When lots of shares are purchased, the stock price rises higher and higher. When the stock price rises higher and higher, the more the hedge funds were losing. The little David’s of Robinhood, were taking down Goliath.
The story isn’t over, but here are a couple takeaways:
- Short-term wins may not last. Hedge funds were able to unwind their “short” positions to limit further losses and the GameStop rally lost steam. Those who bought GameStop and held may now be facing large losses. There is a lot to be said for taking a stance for something and supporting it. It’s another to mortgage your financial well-being in doing so. Playing with savings isn’t wise, no matter how well intentioned.
- This may lead to more regulation for the non-bank sector. Maybe even for a company like Robinhood that makes trading almost game-like. The key is that investing can be dangerous and we’re seeing people being taken advantage of through these headlines the last two weeks.
- Protect your grandkids and your kids. Access to investing is a wonderful thing. Standing up to bullies (how they felt about the hedge funds here) is a wonderful thing. But not understanding or being educated about risk is a dangerous thing.
Remember, investing for your goals should be about diversification, not big bets, and staying the course, not day-trading. Think of it like watching paint dry, not riding a roller coaster. And please, teach your children these philosophies too!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Companies mentioned are for informational purposes only. It should not be considered a solicitation for the purchase or sale of the securities. Any investment should be consistent with your objectives, time frame and risk tolerance.
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