GameStop Trading Frenzy: A Summary of What Happened
February 5, 2021
Over the last week, much of the news surrounding the stock market has centered on the incredible volatility of a handful of stocks, in particular, GameStop, a video game, consumer electronics and gaming merchandise retailer. The extreme trading activity wasn’t limited to GameStop and included names such as Blackberry, Bed Bath & Beyond and AMC, to name a few. These stocks had several traits in common, including low share prices, struggling business models and sizeable short interest.
This is a multi-faceted story that includes short selling, social media, trading access and changes in retail investor behavior. The following is a brief recap of these recent events and what this means to you as an investor.
To understand what has gone on with GameStop, it helps to have a basic understanding of short selling and how it was applied. Short selling is when an investor “borrows” shares of a particular stock, which is usually done through a broker, who usually backs or collateralizes the loan, for a fee. The investor who borrowed the shares then sells the borrowed shares at the current market price, with the expectation that the stock price is going to go down. The short seller is counting on buying back the shares that they previously sold at a lower price and returning the shares to the broker they borrowed them from. The short seller’s profit consists of the difference between the market value at which they sold the shares and the price at which they had to buy the shares to return to their lender.
Based on poor company fundamentals, hedge funds and other large investors were convinced that GameStop’s share price would decline. These large institutional investors engaged in significant short sales of GameStop stock, convinced that they would buy back the shares at a lower price in the future and pocket a substantial profit. By some reports, approximately 140% of the shares of GameStop had been sold short.
This is where low-cost online trading, social media and populism become part of the story. The Wall Street establishment in the form of hedge funds and large investors were betting against GameStop with large short positions. At the same time, thousands of small, individual investors, many of whom shared investing ideas and strategies in online forums, including the online forum, Reddit, saw an opportunity to make a financial profit by working against the investment establishment. The rise of low and no-cost online trading platforms, the most famous of which is Robinhood, became the conduit for convenient, low-cost trading. Based on an idea discussed in a community on Reddit, thousands of individual investors made small investments in GameStop, knowing that eventually the short sellers would need to buy back the shares of GameStop – effectively creating a “short-squeeze.”
Driven by the demand from the individual investors as well as the fact that the Wall Street firms needed to cover their short sales, GameStop stock increased nearly 1500% at one point. Some of the upward pressure in price was driven by retail investors who were not part of the “short-squeeze,” but saw the escalating stock price and had a fear of missing out on its appreciation.
The wild swings of GameStop provide evidence of the significance of the online community and the individual investors on the Robinhood trading platform. When Robinhood, subject to additional capital requirements, had to temporarily block its customers from trading GameStop on their platform, the price of the stock dropped considerably. As soon as Robinhood re-enabled trading for GameStop, the stock changed course and its share price once again took off in a meteoric rise.
It is important to note that none of the recent volatility in GameStop stock is based on any material changes to the underlying fundamentals of the company. While all investments in stocks involve risk and some degree of speculation, we believe that a company’s financial results, sales, growth prospects or other material factors are what ultimately drive a its stock price. From time to time, imperfections or “bubbles” arise in the market.
Recent events open the question of whether the combination of increased retail investors, low cost and accessible trading platforms, social media and a rise in populism could potentially change the dynamics of financial markets in the future.
We believe having a firm understanding of one's investment objectives and risk appetite while staying focused on fundamentals are the best ways to achieve success in the market. A thoughtful, well designed, long-term plan is the best way to build wealth. This is what we do for our clients through our Wealth Management Services team.
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These facts and opinions are provided by the Cape Cod Five Trust and Asset Management Department. The information presented has been compiled from sources believed to be reliable and accurate, but we do not warrant its accuracy or completeness and will not be liable for any loss or damage caused by reliance thereon. Investments are NOT A DEPOSIT, NOT FDIC INSURED, NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY, NOT GUARANTEED BY THE FINANCIAL INSTITUTION AND MAY GO DOWN IN VALUE.