Reddit/Gamestop Trading Frenzy: What Have We Learned?

February 16th, 2021 by Tanner Wrisley

A few weeks ago, the stock market saw a number of meteoric rises from a number of specific retail stocks. These companies had no new news or change in outlook to their fundamentals to justify the quick increase in stock price. In fact, most of the companies that shot up were some of the hardest hit by the pandemic due to the closure of indoor shopping and consumption. So why did they experience this sudden increase? Gamestop (GME) up by over 1500% and AMC Entertainment (AMC) over 500% in a few days? You may have heard the story by now. While there was certainly an element of mania to this event, there are also things we can learn.

What happened? In case you missed it…

  1. This unique stock market incident was set off by an analyst stating and advocating for a short position in Gamestop.
    1. A short position is when you sell a stock first, then buy it back to close your position.
      1. Because you are doing this in the reverse order, you actually want the stock to go down.
    2. This analyst’s hedge fund and others had large short positions in GME.
  2. After this announcement, a bunch of individual investors on the online discussion website Reddit, banded together and decided to buy large quantities of the stock.
    1. This started pushing GME’s price up.
  3. The sudden jump and story behind it hit social media and more people started piling in pushing the stock up more until it was a story on major television news outlets. While the public was getting wind of the story, these hedge funds were hurting.
    1. When shorting a stock, the short seller is basically borrowing the money they need to buy the stock back and close their position, this is called margin.
    2. When an investor’s margin position goes too high, they are forced to buy the stock back in a process called a short squeeze. This is exactly what happened a few weeks ago.
  4. After the stock jumped, then jumped again, the short squeezed kicked in triggering more purchases of the stock propelling it up even further!
    1. This had the reddit users holding huge unrealized gains.
    2. And it wasn’t just Gamestop, about a dozen retail and “nostalgic” stocks experienced a similar phenomenon.

What else happened?

At this point, news of this stock market anomaly was widespread and many individuals wanted in on the fun, especially the millennial crowd and younger generations. One of the most popular places to trade stocks amongst that age group is an app called Robinhood. The scales started to tip when Robinhood halted the ability to buy GME on their platform. The majority of Gamestop’s buyers were on Robinhood’s platform. So, when they froze the ability to buy the stock, the buyers were gone and the stock plummeted.

Robinhood’s sudden halting of GME called a lot into question. The company claimed the reason they did it was because their clearinghouse was not prepared for the volume they were seeing and they were going to run into liquidity issues. This could certainly be true, but for an app whose mission is “finance for all”, they certainly swept the rug out from many people’s feet. So much so that the SEC is investigating to see if there was any collusion with the hedge funds. Regardless of the SEC’s findings, Robinhood facing numerous lawsuits from investors who feel they were wronged.

Where are we now?

While the SEC and others investigate, Robinhood has since lifted all restrictions on their platform. Gamestop started off at around $20/share in mid-January. At its peak on January 28th, it traded as high as $483/share before crashing back down to around $50/share where it is trading as of this writing. In the end, there certainly could be some of these individual investors who timed it right and made some money. But for the most part, the “little guy” probably ended up losing to the hedge funds by buying in the frenzy and are now left with 50% -75% losses.

What does this mean?

Now that things seem to have settled down, what can we learn from this? Some are arguing that these events were erratic, unpredictable, and have nothing to do with fundamentals and so they should be ignored. I would take an alternate stance. While the “Reddit Mania” was certainly high risk and volatile, was it so unpredictable? With social media and increasing technology, stock trading is definitely changing. You see it time and time again when a large public personally tweets about a stock or a cryptocurrency, it influences the price. If Elon Musk even mentions a company or a crypto, that security starts shooting up.

All this means to me is that there are different ways to make money in these markets. Can you profit or weird or unusual market anomalies? Yes, most certainly. But you must understand the risk you are taking because you can also lose big. There is more than one way to generate growth in the stock market and this momentum, social media, celebrity endorsement trading is just the newest wave. But I don’t think anyone has a full-proof game plan for how to profit from it just yet.

There is little known about investing in this way and anytime you are hoping for extremely high growth in a short amount of time, you are taking on a huge amount of risk. You must be prepared to lose most of, if not all of your investment. Additionally, we could see some changes to the securities industry. As the SEC investigates everything that just happened, there has been talk of new rules and regulations that work to combat sporadic market events like this one.

What should I do?

One great thing about technology and today’s world is that it has made the stock market extremely accessible. Investing not just for the wealthy. Everyday people can make money in the stock market. They key is having a plan and knowing the risks.

At Anchor Bay, we focus on fundamentals and the long-term investing in solid companies with proven track records – quite the opposite of the counter-trading stocks. If you want to try to make a quick buck, you can play the lottery by investing in something like a Gamestop. But if you are looking for serious long-term growth and investing towards major financial goals like buying a house or saving for retirement, our customized investment strategies can help you get there with less bumps and bruises along the way.  As you now know, today’s markets are very complex. It certainly helps to have someone guide you through so you can stay on track with your goals and not get eaten by a hedge