By Steve Lowrie, CFA

Special to the Financial Independence Hub

“You can’t invest without trading, but you can trade without investing. … [T]hinking you’re investing when all you’re doing is trading is like trying to run a marathon by doing 26 one-mile sprints right after the other.” — Jason Zweig

Are you out of breath trying to keep up with the breaking news about GameStop and all the other red-hot trades o’ the day? Here’s a synopsis (to date), and what it means to you as an investor:

Seemingly Unstoppable Games

During the last week of January, a perfect storm of traders converged on the market, propelling the prices of a few previously sleepy stocks into the stratosphere.  Jason Zweig of The Wall Street Journal reported, “From Jan. 25 through Jan. 29, a ragtag army of individuals sent shares in GameStop Corp. up 500%, and sent many others skyrocketing too.”

Reddit Gone Wild

Interestingly, there was no huge, breaking news or major shift in these companies’ fundamentals to explain the surge.  Instead, a tidal wave of trading momentum happened to form on a Reddit forum called WallStreetBets.

Big Short-Sellers Get Squeezed

Whatever inspired the movement, it soon became a force of its own, like an online flash mob buying and holding shares at increasingly higher prices.  Why would anyone do this?  Many may have just gotten caught up in the excitement.

Short-selling involves borrowing a company’s shares from someone else, selling them, and then hoping the price goes down so you can buy them back at a lower price.  You then return the shares to the lender, while pocketing the difference.  If you pay more to buy the shares to settle your debt, you have lost money.  The risk of short-selling is that the maximum profit you can make is 100% (if the shorted stock goes to $0); however, the potential loss can be many times your original investment.  (Theoretically, your potential loss is unlimited if the share price keeps going up.)

If the price shoots upward, short-sellers can face margin calls, requiring them to cough up the difference between the original share value and the fast-soaring price.  Or worse, lenders can demand their borrowed shares back, forcing the short-seller to either find another borrower or buy back the shares in the open market at whatever price they can get.  In the case of GameStop, short-sellers like Melvin Capital Management lost billions of dollars meeting margin calls, which in turn became chum to the feeding frenzy.

Main Street vs Wall Street (David vs Goliath)

In typical fashion, the financial mainstream media has pitted this as some sort of epic battle between thousands of small, individual investors just trying to make a buck vs. the Wall Street/hedge fund fat cats backed up by some sort of rigged system.  Don’t kid yourself.  There were pros and sophisticated traders on both sides of this.  No novice is going to have the knowledge to orchestrate not only a short-squeeze, but an option-based gamma-squeeze on a heavily researched deep fundamental value stock.  At least not without a little help.

Robinhood Parries

As the frenzy continued, many U.S. retail trading platforms – including Robinhood, Schwab, TD Ameritrade, and others – started experiencing trading overloads.  Technical glitches, as well as deliberate trading restrictions, ensued.  Not surprisingly, traders impacted by the lapses and restrictions have cried foul, perhaps rightfully so.

Enter the Regulators

Is the phenomenon just a new, but a legal variation of a very old market mania theme?  Did anyone actually violate existing regulations, and if so, whom?  Are new regulations warranted?  Securities regulators are considering these questions, not yet resolved.

Now, to the main point.  Where does this leave YOU as an investor?

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