Lessons Learned from the Gamestop Craziness

Being of a younger generation, a good portion of my childhood involved me begging my parents to take me to GameStop to purchase the latest and greatest video games of the era. Admittedly there is a twinge of excitement when I see GameStop back in the news, like an old favorite band coming back for a reunion tour. Of course, the reason it’s in the news of late is because of the amount of attention the company has garnered in the investment space. On one hand, it’s great to see generational peers thinking about investments, but unfortunately not much is being learned here about investing. Rather, we are hearing stories about speculation and, basically, gambling.

As we see it, investing is about allocating capital to the places that will most efficiently use it, and will pay a fair return for the use of your capital. In contrast, speculation is about allocating capital to places where you think market forces will cause a change in price, so you can get back out with a profit. Speculation thrives on technical analysis, looking at trends and charts to make a guess about where the price of something is going. When you see stock traders portrayed in films, it’s often a well-dressed person sitting in front of eight computer monitors looking at charts and market activity, barking out orders between sips of coffee. This is a portrayal of technical analysis, albeit a touch over-dramatic.

Don’t get us wrong, speculating, as gambling, can be done in an educated and sophisticated way. There are professional poker players who make a living based on real skill, and casinos make money by tilting the odds in their own favor. But speculating is a whole different discipline from investing, and not many people succeed at it. How many people do you know who are able to make a living playing poker? It’s like finding the one person who makes it as a rock star. And the “casinos” of the investment world are basically the big investment banks, who have the resources and processes to tilt the odds in their favor.

So back to GameStop – what exactly happened there? Well, members of an online forum, called WallStreetBets, identified a situation in which hedge fund managers had taken big bets on the stock declining (“short positions”) and were therefore vulnerable. The hedge funds were vulnerable because if the stock increased in value instead, they would lose money, and potentially an unlimited amount. Recognizing this vulnerability, the WallStreetBets traders feverishly bought the stock and convinced others to do so as well, pushing the price of the stock way up. When this occurred and the hedge funds were forced to cut their losses and close their positions, they were then buyers of the stock, which forced the stock even higher. This is called a short squeeze. The advent of social media allowed the WallStreetBets group to communicate and band together and control much more capital than they would ever have been able to muster individually, which caused the short squeeze on Gamestop, and in turn pinched the hedge fund managers all while making a profit for the WallStreetBets traders if they managed to get in and out at the right times.

Great story – the little guy prevails – but don’t get too excited. It doesn’t always go that way, and with the exception of those few talented poker player-type speculators, most people who dabble lose money. One of my colleagues tells the story of how his grandparents took him to the horse racing track for the first time when he was about 12 years old. He bet $2 on a longshot horse, 40/1 odds – and it worked, the horse came through and he got back $80. It was the greatest thing ever, however it took many more trips to the horse tracks and losses of far more than original $78 profit to make the truth about speculation clear to him.

As you have no doubt surmised from this and previous communications, we don’t endorse speculation. If you are looking at investments as a way to save and grow your wealth, you want to be an Investor, not a Speculator. That said, when the news cycle falls upon the financial sector, we would be remiss to skip an opportunity to share our thoughts with clients. And for those who are preparing to one day transfer wealth to the next generation, this may be a good conversation opener around the dinner table.