What is GameStop and why does everyone care?
GameStop is a brick-and-mortar video game chain that has fallen on hard times in recent years. Any 1980’s gamers will recall that we used to purchase “cartridges” for our Atari that held the software for our games. As technology advanced our cartridges were replaced by CDs and, today, most games are simply downloaded via the internet. GameStop has been hurt because their bread-and-butter business is selling the CDs and ancillary products for gamers.
A company with an outdated business model is where “short-sellers” like to look for opportunities. Basically, short sellers do the opposite of most investors. They try to make money when a stock’s price falls. They borrow shares from their brokerage for a fee, immediately sell them, and plan to buy them back later at a lower price when the price falls. Many “hedge funds” utilize short selling. When a stock price begins to fall, they often pile on, selling shares in the open market and driving prices down further and further.
The mechanics of how short-selling works is not important here. That’s a topic for a whole different blog. What you need to know for this discussion is that short sellers make money when a stock price falls and they lose money when a stock price rises. Short selling is considered risky because, if the short seller is wrong and the stock price does not fall but rises, their losses can be huge. Theoretically, a stock can rise forever which makes possible losses for short sellers limitless.
GameStop hit an all-time high of $62.60 back in 2007. Then, as game sales went more and more online over the next 13 years, the stock dropped to a low of $2.57 on March 02, 2020.
Enter the Reddit short squeeze.
As we already discussed, shorting stocks is risky since any positive news or interest in a company can drive the stock’s price up. When short sellers bet wrong and a stock’s price rises, they can be forced to buy shares at higher prices to cover their losses.
A short squeeze happens when short sellers scramble to buy shares to cover their positions when the stock price is rising. Remember, short sellers lose money when a stock price rises and there is really no limit to how high a stock can appreciate. The more investors who buy and hold those shares, the harder it is for short sellers to find shares to buy (exposing them to potentially huge losses).
With me so far?
Where does Reddit come in?
After it became clear that short sellers were betting on GameStop’s demise, they became the focus of amateur traders on the popular WallStreetBets forum on Reddit. Reddit is a popular community of chatrooms and forums on the internet.
By banding together and coordinating buying activity, these small-time traders boosted GameStop’s stock price far above the recent lows. This put pressure on the hedge funds who held huge short positions.2
Suddenly, the stock price started to surge as tens of thousands of Reddit traders purchased the stock, sending the shares higher. This in turn panicked the hedge fund “shorts” who lose money as the stock prices rises. Many of them began buying back their shares which added more fuel to the GameStop fire.
Social media chatter + free trading apps like Robinhood + bull market + new investors with time on their hands + large short positions = FRENZY
As of the writing of this blog, GameStop had risen from a low of $2.57 last March to a high of $483 (an 18,694% gain) in January of 2021, only to fall back to a recent price of $58 per share today (a loss of 87.99% in 7 days for the poor soul who purchased GameStop at $483).
So, should I be investing in GameStop?
For most people: No!!!!! Unless you have a huge appetite for volatility and can watch the stock price all day, this is pure speculation. For people who purchased stock at $300 or $400 per share, today, at $58-$59 per share, they have losses they will likely never make back in this company. GameStop’s stock is massively inflated and trading has been halted multiple times because of its meteoric rise.4
Why are people angry at Robinhood?
Amidst the buying frenzy, Robinhood and other popular brokerage platforms suddenly restricted trading on several red-hot stocks, including GameStop.5At one point, Robinhood limited each client account to only owning one share of GME stock.
What are the implications of this frenzy?
There is no predicting the future, obviously, but we think a few things are likely. Most bubbles end naturally when the euphoria turns to panic, folks start selling, and the price crashes.
However, it’s also possible that regulators will step in if they think there’s risk to markets (or see too many investors getting hurt).
Lastly, crowd investing is likely here to stay. When small investors band together to make investment moves, it seems to us that a playing field dominated by institutional investors may be leveled. Interest in the stock market and people learning how to invest is a good thing in our opinion.
This is an evolving situation, so we are keeping a close eye on the markets to see what might happen next.
Questions? Thoughts? Send us an e-mail or give a call to our office at 231-723-8373.