3 lessons learned from the GameStop short squeeze

Staci West 04/02/2021 in Basics

It’s not very often my husband asks me something about my job other than a polite ‘how was your day?’ So, when he first asked me ‘what is shorting’? whilst walking the dogs, I was very confused. Then he told me about the GameStop story. I was hooked. Talk about David v Goliath: Reddit v Wall Street is a story I’d follow any day. So, what happened?

“Money is a tool. Used properly it makes something beautiful – used wrong, it makes a mess!” — Bradley Vinson, self-help author

Setting the scene

James Mahon, manager of SVS Church House Tenax Absolute Return Strategies, says the recent short squeeze has as much to do with the political background in America as anything else. James elaborated, “personal savings, particularly in America, are very strong. [And] you’ve got this funny background thing going on, where you’ve got a country that’s really quite spilt and you’ve got all this money [from the stimulus package] sloshing around too. So, guess what, lots of people are sitting around, rather bored, and, if you put that all together it’s not surprising that they’ve seen opportunity to bash Wall Street. There is that pent up sort of aggression.”

Enter Reddit

Pent up aggression. Boredom. Bandwagon bias. Whatever you want to call it, in only a dramatic way that the current unprecedented world we live in could offer, a Reddit message board turned the stock market upside down.

According to Bloomberg, 144% of GameStop’s stock was sold short. This happened because short sellers – who have borrowed stock – have then lent it on to other short sellers – thus, it gets counted twice. Ultimately, hedge funds have been betting against GameStop by shorting the stock in a quantity larger than the actual number of available shares. Seems like it shouldn’t be possible, but it is.

Remind me what shorting is again? Chris Kinder, manager of Threadneedle UK Extended Alpha explains what is shorting in this video

GameStop’s share price rose from $20* on 11 January to a staggering high of $483* just over two weeks later. Users on a Reddit message board bought the stock in masses, pushing up the stock price and forcing those who had shorted the stock to buy it back at a higher value. Hedge funds lost billions and it quickly became news.

What is bandwagon bias?

Bandwagon bias is just as it sounds: doing what everyone else is doing. As we learned last week, bias can influence how we interact with money and make decisions. Following the crowd can come with a high price. This is because popularity, like say a global story on GameStop, can drive up prices – sometimes higher than deserved.

Read more about the psychology of money

As AXA’s Chris Iggo points out, “I doubt many mainstream investors are involved in ramping up prices of low cost stocks or running massively leveraged short positions through the options market.

“Buyers coming together on a social media site to “teach hedge funds” a lesson is not behaviour characteristic of long-term investors focussed on structural economic trends, value and earnings growth. It’s more like game theory, pushing those on the wrong side of a trade as far as they can tolerate losses without capitulating. Price moves can and have been dramatic as a result.”

In the case of GameStop specifically, there’s argument that the stock was undervalued and could have seen a natural (more subtle) rise. In August 2020 the share price was closer to $5, but had been on a steady incline to $20 after the announcement on 11 January 2021 of three new board members, including billionaire investor, Ryan Cohan. This rise in early January was arguably a reaction to shareholder news and optimism in the company bringing on an e-commerce expert.


3 Lessons to be learned from the GameStop drama

Choose your investments wisely

If you’re going to invest directly in stocks as an amateur, only do it with money you can afford to lose. Trading might feel like a game, but it’s real money. Share prices can change in a matter of minutes and everything could be gone.

If you have money to invest, spend your time researching and choosing the best option for you. Don’t conform to bandwagon bias. The high volatility of a short squeeze is not where most people want their retirement money – or even savings going!

Investing is a long term game

Say, for example, you bought GameStop at $88, which is the opening price on 26 January, the day I first heard about the story. You’d have watched the share price increasing rapidly as the storying gained traction, and could have been planning how you would spend your new fortune when it reached that high two days later.

Except unless you sold, the huge gain was just on paper. A week later, the share price is just $95*. And imagine how much money you could have lost if you invested on the 28 or 29 January!

Shorting is best left to the experts

Shorting allows investors to make money from falling prices or stock markets. It also provides an opportunity to take a view on a stock where they think earnings or growth expectations are out of kilter with reality. This is what happened in this case with GameStop. Hedge funds saw a brick and mortar gaming store amidst a pandemic and digital download games, and they thought the value would continue to fall.

However, shorting is complex and risky. As such, many professional investors combine long and short positions in their portfolios to improve the chances of generating a positive return, regardless of market conditions. Mark Swain, co-manager of Sanlam Enterprise fund (at the time called Smith & Williamson Enterprise) told us about how shorting helped mitigate some the stock market falls during the initial pandemic falls in 2020.

*Source: New York Stock Exchange

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