When Will the Game Stop?

What is GameStop and a Short Squeeze?

The past couple of weeks have brought “GameStop” and “Short Squeeze” to the forefront of the daily news cycle. It’s a great opportunity to reinforce some key points about market principles.

GameStop describes themselves on their website as a digital-first omni-channel retailer, offering games and entertainment products in its over 5,000 stores and comprehensive e-Commerce properties across 10 countries. They’re also a publicly traded company that you can own a “piece of” vis-à-vis ownership of their stock.

• STATEMENT – For the purpose of understanding what happened over the past couple of weeks, you just need to know that GameStop is a publicly traded company.

Why GameStop?

There is/was nothing particularly special about GameStop. It was just the “tool” that some “investors” chose to pursue this time around (and I use the term “investors” loosely, as I see what is going on here as speculation versus long-term investing).

What about the “short squeeze”? Well, that’s pretty easy to understand as well. Let’s break it down:

What is a short squeeze?

• When you are “short” a stock it means that you do NOT own the stock; rather, you what you did was “borrow” somebody’s stock, and then you sold it—and promised to give them their stock back at a later point in time. You give the stock BACK to them by buying a share in the future.
• Essentially you are SELLING a stock BEFORE you buy it.
• The implication is that if the stock goes DOWN in price you make money. Example:
  • You borrow a share today and sell it at the market rate of $10:
    • $10 is in your pocket.
  • The stock drops to $1 tomorrow, and you buy a share at $1 and return it to the person from whom you borrowed it:
    • This only costs you $1 (out of the $10 you had in your pocket).
  • Net result in this example is you made $9.

What was different about GameStop stock?

So, here’s what happened with GameStop:

• “Normal”
  • Some folks thought that GameStop had potential to go up. So, they bought shares of the stock. Supply and demand being what it is, that started pushing the price of the stock up.
  • There were some other folks that thought it would go DOWN. So they “sold short.”
  • This happens every day, with just about every stock. Some folks think the price is heading north, while others think the price is heading south.
• “Abnormal”
  • The folks buying were all talking via social media and ALL decided this would be a good idea.
    • Lots of buyers means lots of demand, which means up goes the price.
    • These were the “little guys” – lots of small investors.
  • The folks “selling short” were the big, “smart” guys—the hedge funds you heard of.
    • They saw a bunch of fools messing around with what they didn’t know, so they swooped in to make a killing on what they saw as an overpriced stock.
  • The internet and online trading platforms created MASSIVE visibility on this topic, and the trading took off—driving the price through the roof.

The POTENTIAL to lose billions of dollars

Here’s where things get really interesting!

The “shorts” (those who “borrow” the stock, the hedge funds) make one dollar for every dollar that the stock price goes down, BUT they LOSE a dollar for every dollar that the stock price goes up. Big movements up equals big losses for the shorts!

• “Response”
  • The “shorts” quickly found themselves in a place with the POTENTIAL of losing BILLIONS of dollars. NOTE: It’s only potential, as their “bank” (who they borrowed the stock from) first has to ask them to “close out” the deal by buying back the stock—and, until they close out, they don’t actually realize the loss.
  • IRONY COMING – As they (“the shorts”) bought back the stock, they created more demand, which drove the price up further! This is the “short squeeze” that happened. The more they try and get out of trouble, the more they end up getting in more trouble!

As the [hedge funds] bought back the stock,
they created more demand, which drove the price up further!
This is the “short squeeze”

• The “shorts” (hedge funds) asked their friends (other hedge funds) to loan them stock (i.e., essentially asking their friends to “trust them” as they “knew” the stock was going to go back down in price). This was the hedge funds trying to wiggle out of the squeeze by bringing more capital into play.
• The little guys kept communicating on social media, and the price kept going up! This made things tighter for the hedge funds!
• And then things got REALLY interesting in that some of the platforms (Robinhood, Interactive Brokers, etc.) where the little guys were trading said “you can’t buy anymore.”
  • The inability to buy dropped demand and caused prices to start heading back down.
  • That’s when the little guys called “foul,” and folks started yelling that the playing field was not fair.

The story is still playing out. I have absolutely, positively no idea what will end up happening. But it has been great fun watching the market play out.

Key Points – What we all can learn

Some key things to take away:

• Supply and demand works. It can and will move prices.
• There is always someone that is buying and someone that is selling. That makes the market.
• Markets can move very quickly and allow cash to flow where there is perceived mispricing.
• Near term, the price of a stock can be totally INDEPENDENT of the underlying financial status of the company and, instead, be entirely driven by other market forces.
• No one “knows” what the price of a stock will or will not do. And if they do, it’s 99.9% certain that they are trading on insider information that is very likely illegal.

My reaffirmed faith in holding a well-diversified portfolio

I have never recommended that someone speculate on a stock for short term gain. Furthermore, I can NEVER envision myself getting in a position where I “short” a stock—doing so presents limited upside and unlimited downside risk.

The GameStop story has reaffirmed my faith in holding a well-diversified portfolio and sticking to a pre-defined Investment Policy Strategy over time.

While I won’t get the massive gains the little guys walked away with—and many did great over the past few weeks!—I won’t experience the “squeeze” that hedge funds did over the past couple of weeks either!

You will just need to decide if you want to play a game with your savings
or if you prefer to pursue a data-driven, fact-based investment approach.

Bottom line is that the situation with GameStop will likely come to a close in the next few weeks; however, the game will never stop.

You will just need to decide if you want to play a game with your savings or if you prefer to pursue a data-driven, fact-based investment approach.

Would You Like More Support?

• Do you have a well-defined Investment Policy Strategy that is used to drive your investments in support of a comprehensive financial plan?

• If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner while focusing on your desired outcomes?

If so, feel free to send us an email or give us a call. We’d love to have the opportunity to help you find a bit more peace of mind when it comes to investing.

Photo credit: Clay Banks on unsplash.com