What to Make of Recent Market Hype
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There’s little doubt that the markets of 2020 acted in some surprising ways, but that was nothing compared to what happened in the markets during the week of January 25th. Whether you invested in it or not, you likely heard about how a group of investors on Reddit drove up the stock price of GameStop from around $39/share on January 20th to a high of $483 on January 28th.
So, the questions are what happened and what should we do the next time it happens/how much attention should we give to this type of hype event?
The short (and long) story
You may already understand what selling short is, but in case you don’t or don’t remember, here’s a refresher. Short selling is when you borrow shares of a stock that you think will go down in price in order to sell it now, with the plan being to buy it back when the shares decrease so you can return the stock you borrowed and profit from the difference. For example, you sell XYZ stock at $100 and it goes down to $50, you buy it and return the shares, keeping the $50/share difference in price.
The challenge is that if the price increases, you can lose a lot of money. If the shares of XYZ rise to $150, for example, you’re losing $50/share when you have to replace the shares.
A number of hedge funds had taken significant short positions in GameStop because the stock had been trading under $20 for the better part of 3+ years, so when it went to around $40, they believed it would go down. The group on Reddit could accomplish two things by purchasing the stock en masse:
- They could start driving the stock price up so they could profit significantly in a short amount of time
- They could cause significant losses for the hedge funds—who drove the stock up further as they frantically tried to buy back the stock to limit their losses (it’s estimated that this cost hedge funds $5 billion)
- They could make a political statement about Wall Street institutions
There were a number of other issues you may have heard about including how RobinHood, a popular investing technology for independent investors, paused trading a few times. Contrary to popular belief, it wasn’t that they were bowing to pressure from Wall Street, but were trying to meet regulations for deposits on hand and to reduce their own exposure (risk) to the stock. You can learn more about the whole thing from this informative video by the 401KLADY.
While there currently aren’t regulations to stop this type of investment hyping from happening again, there likely will be in the future. But for now, you may be wondering if you should try to jump in on something like this the next time it happens. To answer that, consider the following:
- We heard a lot about how individuals profited insanely in a short amount of time, but lots of investors lost money too. While the stock is still far above the long-term average (as of February 10th, it was between $50-$60/share), lots of investors who jumped on the bandwagon at $120, $200, $300 and more have now lost significant value per share.
- When it comes to investing, you should keep a focus on the long-term. Trying to manage a portfolio by riding these types of waves will be incredibly challenging and more than a little bit painful.
- Research has proven that, for most of us, by the time we hear about something like this, it’s already too late to benefit.
Gasber Financial is here to help you simplify the markets and your finances. We’re happy to help you with any questions you may have about this or other events.