This past week shares of GameStop, BlackBerry, AMC, and others have caught the attention of the media. By now, it is well known that novice investors have banded together to put a "squeeze" on hedge funds shorting these stocks.
Merriam-Webster defines rebellion as opposition to one in authority or dominance. This is the perfect term to explain what is going on in pockets of the stock market right now. While this may be amusing to watch, what are some things we can take away from these recent events?
- FOMO is real: According to Google Trends, the term "GameStop Stock" was searched over 10 million times on Wednesday, January 27th. This is up from 1 million on Monday, January 25th. The number of shares traded hit a record high of more than 195 million on January 22nd. This is more than 78X the number of GameStop shares that were traded 12 months ago.
The crowd has moved into GameStop. FOMO has taken over. The psychological term for this in finance is "herd mentality". The herd moves in one direction because people fear not being on the train when it departs the station. History is a powerful lens, and history tells us when the herd all moves in one direction, it typically does not end well (think about the tech bubble of 2000).
In these "heat of the moment" events, it is often helpful to take a step back and remember why you invest in the first place. When buying a stock, you are taking your hard-earned money and buying a stake in a company in hopes the company will grow in the future and earn you a return on your investment. In October 2020, GameStop reported a quarterly loss of $2.57 per share, yet the stock is up almost 3,000% since that announcement. Is this because the company has an optimistic future? Possibly, but it seems that optimism is a bit excessive. Is some of this increase due to FOMO? Probably. The question to ask yourself before buying GameStop at $300/share is, do I want to own a business that is currently losing money?
- No such thing as a free lunch: The internet is a phenomenal vehicle in which to access and share information. It is also a perfect vehicle to disseminate false or misleading information. (Don't get scared. This is not a political rant.) If Bob Jones on Reddit says you should buy GameStop, you might glance at it. It packs a little more punch when it comes from a guy with a Username of StockGuru (yes, we made that name up). Who are these people? It could be an individual investor who thinks she has a good idea. It could be a trader at a big brokerage house trying to change market sentiment under the guise of being a regular Joe.
Let's say you want to jump on the bandwagon and "stick it to the man" so you pile in and buy a few shares along with thousands of internet "friends". Over the last year, GameStop has traded between $4 per share and nearly $500. Only 3 weeks ago, it traded around $20. While the people who got the initial enthusiasm rolling likely made a killing on this trade, there will almost certainly be billions of dollars lost. There seems to be too many similarities to Ponzi schemes and those never end well. Be careful about jumping in to get your piece of the "free" money.
- Diversification works: While the media is focusing on the huge runup in GameStop shares, there has been an opposite side of this trade where the "short sellers" have lost billions by getting caught up in the buying frenzy. This is known as a short squeeze. While this frenzy buying is currently siphoned off to a few names, it still speaks to the power of diversification. Stocks can go up or down for any given reason on any given day. Imagine only holding 5 stocks in your portfolio. If just 1 got caught on the wrong end of volatile trading, or perhaps panic selling, it could quickly shave 20% off your portfolio. By focusing on diversifying your investments, you are lowering the risk of getting caught on the wrong side of these market anomalies.
While the events in the past several days have gathered massive media attention, it is important to stop and think about what we can learn from these wild market events. The GameStop frenzy has taught us that herding behavior is not a thing of the past and that nothing is ever truly "free". The crazy runup in the stock has also provided a powerful reminder that good old diversification is alive and well. Stay tuned as we continue to follow the events unfolding in today's markets.