At this point most everyone has heard of the craziness surrounding GameStop stock over the last few weeks. There are several things we can learn from the madness. First I will try to explain as simply as possible, what actually happened.
Retail stock market traders banded together in the Reddit forum “WallStreetBets” and decided to buy, and encourage others to buy, GameStop Stock. The main reason they did it was because they knew many Hedge Fund managers had shorted the GameStop stock. Shorting a stock is basically betting that the stock is going to go down. In slightly more technical terms, it means they borrowed money to then sell the stock, in hopes to buy it back later at a lower price. The higher demand for the stock increased the prices, which caused the hedge funds to buy the stock to decrease their risk before the stock price went even higher. This caused prices to shoot up even faster. This compounded and went viral which caused the stock price of GameStop to go from about $40 per share, to almost $500 per share in just a few days. Many Hedge Fund managers lost Billions. On top of this, due to the volatility, RobinHood and a few other retail trading platforms would not allow retail investors to buy into the stock for a few days. And now, the GameStop stock has continued a free fall back to reality, and the thousands of people who tried to jump on the bandwagon, have most likely lost a large chunk of change. From the peak of almost $500 per share, to now under $60 per share. That’s an over 80% drop from just a few days ago.
What can we learn?
First and foremost, short selling is not a good idea. Short selling always involves borrowing money, selling a stock, and then you have to buy it back. The risk is literally infinite, because there is no “max” stock price, it can just keep going up forever and ever. Many hedge funds and riskier mutual funds use this tactic. We have never, nor will we ever use this tactic, as it turns investing in the stock market into full out gambling.
Secondly
Playing the Individual stock ownership game is very risky. Yes, a few people officially “got rich quick” if they were able to get in on Gamestop at the exact right moment and get out at the exact right moment. But a majority of retail investors got in after it was in the news and now the price is already lower than it was when they got in. Everyone thinks they can be the one to buy at $40 and sell at $500, but all too often stock pickers are the ones buying at $500 and selling back at $40.
If you pursue a stock-picking strategy, you are almost certain to lag the market.
Stock pickers always underestimate the number of variables that are involved in the pricing of stocks. There are literally trillions of variables that could occur on any given day that could change the price of a stock instantly. Stock prices are based on every single investor which all have different feelings about companies, reasons for investing, and regional bias.
The big problem for investors is that even though stock-picking is very risky and usually hurts returns, it’s extremely interesting and makes for a great conversation.
You may have decent odds at picking stocks that beat the total market before costs (just like a monkey you have a 50% chance), but it is much harder to do so after costs are added in. So lets say you happen to pick stocks well enough to boost your return by a couple of points, the expenses you rack up along the way (ie. research, trading costs, taxes, bid/ask spread) will usually more than offset your gain.
If you are trying to get rich quick, and have money to lose, then go for it.
The Opposite of Stock Picking
If you want to invest in the stock market in a way that is not similar to gambling, invest in a globally diversified portfolio managed by an investment coach that will help to educate you on the investing process. Instead of constantly turning the portfolio over by stock picking and active trading; buy, hold, and rebalance when necessary. Long term you will see the fruits of your decision.
By Jimmy Hancock
References
“GameStop Corporation (GME) Stock Price, News, Quote & History.” Yahoo! Finance, Yahoo!, 8 Feb. 2021, finance.yahoo.com/quote/GME?p=GME.