A Brief Explanation of the GameStop Trading Fiasco
If you’re confused about why GameStop stock has dominated the financial news cycle in the last few weeks you’re not alone. A year ago GameStop stock traded around $5 per share, late last month it went as high as $483.
Like a lot of financial markets phenomena, there isn’t just one root cause underlying the recent GameStop bonanza. Below I’ll break down four of the biggest factors behind these recent events and what lessons they offer for financial planning clients.
GameStop – Failing Retailer or Deep Value?
For those who may be unfamiliar, GameStop is a video game retail store founded in 1996. For years it was the go-to spot for kids and their reluctant parents to fork over increasingly ridiculous amounts of money for the newest video game or video game system. Fast forward and, like many retailers, GameStop has struggled as consumers embrace online retail (hello Amazon!) and video games slowly shift toward streaming platforms (think Netflix for video games). However, GameStop showed signs of transitioning toward an e-commerce model in 2019-20, attracting the attention of a few big-name investors but also a few members of a small investing group that use a social media site called Reddit.
Reddit – The Home of WallStreetBets
Reddit is a unique place among the social media landscape as it serves as more of a news aggregation and discussion forum than a traditional social media site like Facebook. It is known for its thousands of different discussion groups that focus on particular topics. One of these groups, called “WallStreeBets” (WSB), is an infamous group that discusses stock and option trading and speculation. The group is known for its popularity amongst younger traders, gravitation toward riskier forms of trading, and the use of zero-commission brokers like Robinhood. Within WSB the topic of GameStop became increasingly prominent, which coincided with several prominent hedge funds shorting the stock, hoping to profit from its demise.
Hedge Funds – Villains of the Short Squeeze?
Short sellers, whether individuals or hedge funds, are betting that particular stocks will go down in price (see graphic below).
The WSB community, however, noticed more than 100% of GameStop’s shares had actually been sold short! This realization painted the hedge fund traders as greedy, nebulous villains, hoping to feast on their beloved retailer’s downfall. At this point the band of WSB retail traders rallied around GameStop and began buying shares en masse. More and more speculators hopped on, trading volume increased, the share price rose, and the hedge funds saw their short positions losing money. They started buying the stock as well to hedge their bets, driving the price up even further (what’s called a “short squeeze”). Many hedge funds closed their short position entirely, usually at a steep loss. But more concerning were the brokerage firms that limited or halted trading in GameStop altogether amid the surge in volatility.
Robinhood – From Hero to Villain
Amid this speculative trading frenzy, much of the attention focused on Robinhood, a zero-commission broker best known for being a preferred way for younger generations to invest using their smartphone. During the height of the GameStop volatility they made the choice to block purchases of GameStop, receiving widespread criticism from traders and politicians. Several lawsuits have since been filed against Robinhood (and other brokers) alleging market manipulation or a desire to protect big hedge funds over retail traders. Robinhood alleges they acted to do just the opposite (stop apparent manipulation and honor their duty to settle existing trades).
What are the Takeaways for our Clients?
There are dozens of articles with differing perspectives on what this means for markets, regulators, hedge funds, and individual investors, but what lessons are there for financial planning clients? As always, this is a strong reminder to think thoughtfully and carefully about your investment choices. There is a reason you didn’t get a call from your financial planner encouraging you to join in on the GameStop trade, and that’s because we focus on investing, not speculation. There are plenty of examples of rampant speculation, from the Dutch Tulip bulb bubble in the 1600s to the dot-com crash of 2000-01.
In all of these cases the excitement and the fear of missing out vastly outpaced market fundamentals and rational analysis of the facts. The stock market is not a casino and acting as if it is can yield terrible, and heartbreaking, results This is why your financial planner and our investment team take such care in putting together long-term, goal-oriented portfolios that are built to help you succeed regardless of whatever market craziness we see flare up over time. If this event sparked questions for you about your portfolio or how the markets operate, reach out to your financial planner today.
Written By Zach Reuter, CFP®