The Return of Investors to GameStop

The Washington Post notes that GameStop and other meme stocks are surging again.

GameStop shares closed up 19 percent Thursday, after surging as much as 88 percent, as retail investors returned to the shorted stock that set off a trading frenzy last month that shocked Wall Street and sparked federal scrutiny. GameStop ended the session at $109.15, pushing the video game retailer’s market cap past $7.6 billion, even as the broader market slumped.

What fueled this rise were more small retail investors who benefitted on shorted stocks including GameStop and reacted to news about the company CEO stepping down. This time around investors simply want to see GameStop do well and would like to repeat their previous success with the stock.

What Are Meme Stocks?

A meme stock is one that is both heavily shorted and subject to manipulation to prove a point. The Reddit subsite, WallStreetBets, is popular with young investors. They do not get their investment ideas or advice from Kiplinger, Barron’s, The Wall Street Journal, The Motley Fool, or Jim Cramer. They studiously follow what is posted on WallStreetBets and then invest via Robinhood or another online investment platform. These folks have found that they can make money trading options.

The Post interviewed a software engineer who set aside money in hopes of winning this time around with GameStop. It was money he could afford to lose. Unfortunately, some Robinhood users have mortgaged their homes in order to buy or sell options on Robinhood. Getting your investment advice on Twitter, YouTube or Reddit is fine. As we noted years ago about stock tips, you need to check them out independently. Look at intrinsic stock value if you are looking to invest for the long term and beware of selling options unless you are purchasing as an offsetting measure. As noted in the article, a lot of people are going to learn this the hard way!

Should You Invest in Shorted Stocks?

As noted in an informative article by Market Watch, the vast majority of investors should never short-sell stocks. Folks who do this and make money have done their research and often have what amounts to inside information. They can afford to lose their investments. And, they spend all of their time watching over these investments so that they can reverse course on a dime if need be.

If you have a short position, there’s no limit to how much money you can lose if the shares rise. If the share price increases soon after you place a short position, you could quickly “cover” by buying back the shares and returning them to the investor you borrowed them from. If you’re lucky, you might not lose very much.

Our view of the current meme stock frenzy is that the market is being manipulated by a few savvy investors who also are skilled at using social media to recruit lots of folks to help them achieve their goals. Following these folks may work out for you at times and at other times you are simply being pulled into another pump and dump scheme. The basic problem is that you are betting that enough people will follow the leader on Reddit to cause the short sellers to buy again and give you a profit.

Should You Invest in Shorted Stocks? – Slideshare Version

Should You Invest in Shorted Stocks?- DOC

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Trading and Investing Based on Market Sentiment

The usual clues to changes in market sentiment are to be found by following the VIX index, put to call ratios, the market aversion of or love for safe haven assets like the US dollar, and the breath stock prices. And, in a normal stock trading environment, investors and traders have time to consider their moves. That breathing space is getting shorter due to the emergence of a social media-driven feeding frenzy that has just pivoted from Gamestop to silver according to Reuters.

Silver broke above $30 an ounce for the first time since 2013 on Monday as an army of retail traders stormed into the metal after betting billions of dollars on stocks last week, triggering risks of a multi-asset melt-up in global markets.

The action in silver, following thousands of Reddit posts and hundreds of YouTube videos suggests that a rise in the physical price could hurt large investors with bearish bets, also marks a foray into a much bigger and more liquid market than individual stocks.

This new force in the investing world has the power to drive prices on chosen targets higher in a big hurry only to leave the chosen target in a precarious position once the herd of retail investors moves on to their next target. Because all of this happens outside of the world of fundamentals, traders are left with the analysis of very short term market sentiment as their only recourse, other than avoiding these trades completely.

Investing According to You Tube and Reddit

Reddit calls itself the front page of the internet and includes a group of online “communities.” Prevalent among them during the stock trading frenzy are Wall Street Bets, Robinhood, investing, stock market, and options forums. Retail investors who follow these forums, share their trades, and invest based on the most recent posts managed to drive Gamestop to stratospheric levels before moving to other targets. Some of the posts offer reasoned explanations and some simply are opinions. The sentiment that they produce drives markets and can have huge impacts as more and more readers pile on. Investors post videos on You Tube as well in which they explain their reasoning, hoot about their profits, and try to convince more people to get into the game.

How Much of This Is Pump and Dump?

We wrote about the bitcoin pump and dump at the end of 2019. To the extent that someone has the money to trade, can afford to lose it, and have a professional skill set, they are welcome to bet on this sort of trading. Our concern is that those who are simply betting on stock or silver price rises and basing their bets on a quick look at a You Tube video, are more likely to get hurt in the end than make money. FOMO (fear of missing out) seems to be a big motivator in this situation. If you are going to make money in the midst of a retail investor frenzy you will need to move quickly, accept a reasonable profit, and leave before the rest of the crowd. Otherwise, you will be like too many who put the second mortgage on their home in order to buy bitcoin at $19,000 before it fell back to $6,000 or bought at $40,000 before it fell back to $33,000. In regard to silver, some of us still remember when the Hunt brothers tried to corner the silver market and Silver Thursday when the precious metal fell from over $100 an ounce back to $10 and later back to $6.

Predicting the Next Retail Investment Frenzy – Slideshare Version

Predicting the Next Retail Investment Frenzy – DOC

Predicting the Next Retail Investment Frenzy – PDF

Dumb Money Beats Hedge Funds

As Gamestop stock started to go up over the course of 2020, money managers and hedge funds started to short the stock. Then mom-and-pop retail investors piled in and started to buy. The resulting rise in price resulted in a short squeeze that drove the price even higher. Why did all of those “dumb money” investors buy Gamestop and increase its market value from $2 billion to $24 billion in just a couple of days? The answer lies in the power of social media in today’s stock market.

We wrote about Robinhood investing and the risks involved. Since the Covid-19 pandemic began, many have started to trade stocks and options with apps like Robinhood due to being off work and with time on their hands. Stocks that have benefitted include BlackBerry which is up 280% and AMC which is up 840%.

According to the Times, the credit (or blame) for Gamestop’s rise and the losses incurred by hedge funds and others goes to Wall Street Bets which is a page on the Reddit social media site. The page put out the call to buy Reddit when it became apparent that it was being heavily shorted. And, when lots of small (dumb money) investors purchased the stock the price went up and those with shorts had to buy at a loss, further driving up the price.

What Happens Next with Gamestop?

The stock has already fallen from its peak price and, if left alone, should drift toward its intrinsic value price. But, if the shorts start up again, don’t be surprised if the same pattern repeats itself. Now we see that folks like Elon Musk are posting on Twitter about Reddit. It may well be that accurate market sentiment data will have to include everything said on Reddit about stocks!

Does Tribal Investment Activity Endanger the Market?

When investors have to bail out of their short positions they often have to sell their winners to find the cash. When there are enough short squeezes it could be that over-priced but otherwise solid stocks could be affected. The S&P 500 shuddered a bit after the Fed said that the economy is not doing so well. The sort of perfect storm that starts a market crash could be triggered by a “side show” like Reddit readers ganging up on the Wall Street hedge funds.

Where Does Intrinsic Stock Value Fit into this Picture?

If you are a long term value investor and believe that a stock like Gamestop is worth more than its current price based on its forward-looking earning potential, you will buy it. If you think it is over-priced right now you will sell. If you are a short term trader, the Gamestop situation afforded you with a golden opportunity to make money, provided that you could predict that all of the “dumb money” would go “all in on the stock.” For many who thrive on social media this all makes perfect sense. So, should you invest in Gamestop today? For those who are not glued to their smart phones all day long, this could be dangerous.

Should You Invest in Gamestop? – Slideshare Version

Should You Invest in Gamestop? – DOC

Should You Invest in Gamestop? – PDF