The Retail Investor Burst: GameStop, Reddit and The Squeeze Against Hedge Funds
If you keep up with the markets at all, it’s likely that you’ve seen people talking about the explosion in GameStop (GME) price over the last few weeks. If you are anything like me, you probably look at GameStop as a sort of bygone retailer, going by the wayside in the same way that Blockbuster did in the early 2010’s. However, GameStop’s share price has jumped from around $19 on January 12, to $347 today, January 27. So what is actually going on?
Reddit vs. Hedge Funds
Long known as the villain to common men, hedge funds are known for their elitist qualification programs, and 2 and 20 fee structure (2% annual, 20% of any returns you make.) When GameStop announced a restructuring of their board, including adding some high-profile executives from the ecommerce space, high profile hedge fund Melvin Capital announced a massive short stake in the company. (For those of you who don’t know what a short is, a short position profits off a declining stock price.) While Melvin Capital isn’t wrong in the assumption that GameStop is undoubtably a failing business, that in all likelihood won’t survive the next console cycle, Reddit users on the forum r/wallstreetbets came to the defense of the company, in an effort to “stick it to Wall Street.” Users on the page continued to cheer and urge other users to continue buying shares, as to ‘squeeze’ the shorts out of their position, and have to buy shares to cover the short, which drives the price of the company even higher. As of today, Melvin Capital announced that they had covered most of their shorts, buying shares of the company and causing even further price increases.
While most people are fine with the average Joe winning one every now and then, there is fear that the uneducated Robinhood retail trader’s power may be influencing the market in ways that previously weren’t possible. Many people have made life changing money on the GameStop boom of 2021, but GameStop will inevitably crash back to earth from the current $347 a share, which will hurt a lot more of the ‘average Joe’s’ chasing the market than it will Wall Street.
Human nature almost always tells us when prices are lower, we are more inclined to buy. However, we think almost the exact opposite of this about the stock market. We see a rising price on a stock and think less risk, more profit, and a declining price as more risk, less profit. It is for this reason that chasing the market always ends in someone getting burned, especially on something like GameStop, where we all know what is coming, because we have watched it happen before. There has been outcry for regulations and enforcement of pump and dump tactics to users who have been encouraging other investors to buy shares on Reddit this past week, but it is unknown what action the SEC will take to ensure an event like this doesn’t happen again.
So Should I Buy These Momentum Stocks?
While the average investor has shown how much power they actually hold, which by current estimates, retail investors make up 25% of the market space during the COVID Lockdowns, we should all be careful and remember that timing the market relies on two things: Insider information, or a hefty dose of luck, sometimes both. We know that the best mitigator of risk is time, and with proper planning and allocation, we don’t need to rely on gambles on volatile day trades to get to be extremely successful in the markets. We can plan and build portfolios in solid positions, with fundamentals and missions that we believe in and have high probability of success, but we should be wary of anyone who says they know exactly what the market is going to do in any given period of time, because if the last year has taught us anything, it is to be prepared for the unexpected. There is a big difference between investing and speculating, and any inclination to buy a momentum stock should be given the same probability of success as gambling.
-Colin Feller, President