The Game

The Big Picture

“Markets can be irrational longer than you can remain solvent.” – John Maynard Keynes

An understatement in the least.

So what was the game with GameStop?

For about a week, GameStop was the most important story in the financial markets. GameStop, a video game and gaming merchandise retailer. While there have been some wild theories and proclamations made, there is really nothing here that we haven’t seen before. The only difference was the manner and scale of the GameStop short squeeze. What is a short squeeze? More on that below.

In 2008 I was at a conference and I heard Ted Koppel speak. While I cannot recall the full speech I do remember him being asked what he thought about the internet and the information age as it affected news and its influence on people. His response was one of concern. He found it troubling that anyone could pass information online without any verification of truth. He was concerned that many would believe anything they read! At the time I dismissed this warning but he could not have been more spot on. If it’s on the internet, it must be true!

The statements and claims I have seen regarding GameStop and what transpired are proof enough that not only was Koppel correct, but the extent of misinformation and misguided claims are bordering insanity!  

Have a Plan and a Process!

From the Trenches

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.” 

-Charles MacKay

GME (GameStop’s ticker symbol) was a classic short squeeze. Short squeeze’s are not uncommon. This one was epic in scale due to the manner which it began and the participation in the squeeze. Wall Street Bets, a Subreddit (Reddit is a social news, content and discussion website) started a frenzy here.

So what is a short squeeze? 

Let’s begin with shorting. Going short is the exact opposite of going long, or buying a stock. When you go long, or buy, you expect the price of the stock to go up. The ultimate goal is to sell higher. Easy enough. When you go short, you expect the price of the stock to go down, so you can cover it lower. (We change the terms in shorting from buy and sell to short, or sell short, and cover, or close the short. This is done to avoid confusion on the price actions taken.)

Huh you say?

The mechanics are fairly straightforward. To short you sell the stock into the market with the expectation to buy it back lower, or cover your short. How do you sell first and buy later? This is accomplished by borrowing the shares, and selling them in the market, with the goal to buy the stock lower and profit from the difference of short price and cover price. Yes there is some market plumbing here that is confusing! Bottom line, when you are shorting a stock, you want the price to decline.

But what if the price goes up?

Ruh-Roh. Problem. If the price goes up then you may be forced to cover the short higher for a loss. This is exactly what the short-squeezers intend. In a short-squeeze, investors begin buying with the intention of pushing the price up. The goal is to force those short the stock to cover their shorts, or buy, which drives the stock price up even further.

In GME’s case, the stock rose over 2000% before ultimately retracing the entire move to end nearly where it began.

Bottom Line: Shorting a stock is simply executing a trade where the goal is to profit from the price declining below the short price. 

The Weeds

“Everybody pulls for David, nobody roots for Goliath.”

So to the controversy of the story. Short interest, or the percentage of shares sold short in a security, is published for all to see. You may not know exactly who is short, only that a sizable amount of a company’s shares are currently sold short in the market. Many times, those shorting a company’s stock are larger players such as hedge funds.

Was this really a David vs. Goliath episode? 

Many have looked at it that way. I even watched a U.S. representative applauding the Wall St. Bet’s crowd for taking on the big guys and “winning”. Is this really something to celebrate or even focus much attention on? I would argue it is not. And what exactly was won? Now to be clear I am not sticking up for the hedge funds. In this case it was a hedge fund Melvin Capital that got its hand caught in the cookie jar and lost in the squeeze. Were you aware that most hedge fund customers are institutions, who represent pension funds, labor unions, governments, etc. Goliath, in many cases, are actually the “little guys”.

There is risk in any investment strategy and managing money is a “grown-up” game! So no tears should be shed for Melvin Capital. They are considered professionals and should be fully aware of the risks they undertake. That said, this can’t necessarily be said for the Wall St. Bet crowd. These investors are made up of mostly retail and smaller investors who may or may not know the risks they are taking. While the GME squeeze was a success, don’t forget the stock came back down, as is usual in a short squeeze. The decline very likely adversely effected many holders along the way. In some cases, material losses were experienced.

So did David defeat Goliath? Not really. Melvin Capital is still running, and they very likely continued to short GME after the rise. A very attractive price to short into after a 2000% rise! Who may have been left holding the bag? Many of the smaller investors who bought into the squeeze a bit late and were not able to get out before the collapse. This is my concern, novice and smaller investors getting caught up in the hype of a strategy and not understanding the risk being taken.

Is shorting evil? Why do investors look to short a stock? What happened at Robinhood? I’ll have to leave this for another update but for those who would like to learn more about this event please feel free to contact me.

Bottom Line: Ted Koppel’s warning on the internet was very prescient. Learn all of the facts and risks of the strategy before going mad with the herd!