Unless you have taken a full week off from the news, by now you have encountered someone trying to explain what is going on with GameStop.
Late last month, GameStop made headlines as its stock’s value shot up, the beginning of days of remarkable volatility. The stock began the year at under $20. On Jan. 22, it increased in value nearly 70%. On Jan. 25, the price was so volatile the New York Stock Exchange briefly halted trading nine times over the course of the day. GameStop’s stock reached almost $350 at the market close on Jan. 27 and fell to under $200 at the close on Jan. 28.
For some time, the video game retailer has been struggling with dual realities. First, foot traffic to its brick-and-mortar stores, long trailing off, suffered further during the pandemic. Second, video game fans increasingly buy their games as direct downloads rather than as physical discs or cartridges. While some bystanders had recently seen reasons for optimism – such as new board members and reports of a shift to focus more fully on e-commerce – none of that news was the major engine for the spike in GameStop’s stock price.
That engine was an army of day traders.
As many people, including me, observed last year, the COVID-19 pandemic coincided with an increase in trading from individual investors. Many of these investors took to Reddit to discuss their approaches. In GameStop’s case, it is clear that much of the momentum began in the subreddit WallStreetBets. What is less clear is whether the majority of these traders sincerely hoped to profit or whether, as Emily Stewart put it for Vox, “they’re just ‘YOLO-ing’ themselves across the market.”
GameStop caught the attention of retail traders, especially on Reddit, not only because of positive news about the company itself, but because so many market professionals had bet against it. A large group of retail investors determined that, by acting together to drive up the value of GameStop’s stock, they could hurt hedge funds and other institutional investors that had shorted it. Observers have debated the extent to which this motivation was primary or secondary, but it is clear it helped drive the trend to some degree.
This is different than a classic bubble, where optimistic individuals lose sight of the risks involved and invest with the assumption that they can’t lose. Instead, GameStop investors are actively banding together to try to drive one stock’s price up by creating an overwhelming level of demand, effectively breaking the typical market environment where buyers and sellers are matched together to agree on an appropriate price. While some have speculated that the GameStop incident might trigger regulatory scrutiny about potential market manipulation, that outcome seems unlikely. As far as we know, no one was acting fraudulently or with any nonpublic knowledge.
Anyone who holds a concentrated stock position is vulnerable to the unexpected. A company’s stock can suddenly crash while the rest of the market is unaffected due to business-specific risks that are difficult to anticipate. For example, cruise line investors could not have anticipated a deadly pandemic. Boeing investors could not have anticipated the pair of deadly crashes that grounded the 737 MAX and undercut public trust in a well-established company. Unforeseen events can tank a stock, temporarily or permanently. This isn’t new.
In this case, we saw the unexpected operating in the opposite direction as GameStop’s stock skyrocketed. This episode has created a new risk for investors to consider before opening a concentrated position in one company’s stock: the risk that a coordinated group of investors could decide to do the opposite, and drive a company’s stock down, rather than up. While the mechanics of this could be tricky, it’s not unthinkable that in the future large number of small investors could try to push down the price of smaller, less liquid stocks for extended periods by banding together.
That said, many GameStop investors have expressed disdain for those who bet against companies. This antagonism may be fueled in part by the popular conception that short selling caused or contributed to the 2008 recession. Economists have since argued that short selling was not the principal culprit, but the sentiment persists. For at least some of the traders betting on GameStop, hurting short sellers is not only a bonus, but the goal.
The GameStop saga also highlighted another previously unappreciated risk for those holding a concentrated position. What happens if your broker does not let you trade a stock when you choose? In light of GameStop’s volatility, certain platforms – including Schwab, TD Ameritrade and Robinhood – temporarily restricted trades of particularly volatile stocks. Many day traders reacted angrily, accusing brokerages of favoring institutional investors over “the little guy.” The brokerages argued that the halts were purely procedural, due to the limits of the firms that process transactions on the back end. Regardless, for someone with a concentrated stock position, the prospect you might miss a key moment due to circumstances outside your control is another hazard to bear in mind.
Concentrated positions are always risky. Sometimes the risks are conditions you can see coming, but often they can blindside you. In a properly diversified portfolio, a bolt from the blue can cause some pain, but seldom disaster. The GameStop story is a valuable reminder to expect the unexpected and to avoid the temptation to put all your eggs in one basket.