3 Essential Lessons From GameStop’s Shocking Highs and Lows
Pretend you invested $10,000 in GameStop stock at 10 a.m. Eastern time Thursday. You would’ve had $2,684 by 11:20 a.m.
By 2:10 p.m., you’d have been back in the black with $10,481.
By Wall Street’s close at 4 p.m., your $10,000 investment would have come crashing back down to $4,124. By 5:41 p.m., after-hour trading had pushed it back up to $5,645.
Regardless of when you’re reading, just know this: All these numbers are already ridiculously outdated. Here’s why GameStop has been on such a wild ride and what you should take away as a regular investor.
How Did GameStop Rise 2,500%?
The first thing you need to know about GameStop is that it’s been struggling for several years. The retailer buys and sells old video games, which has been tough as gaming has gone digital. COVID-19 only made things worse.
As recently as August, those shares that briefly spiked to $469.42 earlier today were trading for less than $5. At their low point during the pandemic, GameStop shares sold for $2.57 apiece. Thursday’s short-lived highs represented an increase of more than 18,500% compared to their bottom less than a year ago.
GameStop shares started surging in the final months of 2020. Some people were optimistic for a number of reasons, including a new partnership with Microsoft and Chewy co-founder Ryan Cohen’s announcement that he’d acquired a 9% stake. GameStop stock closed out 2020 at $18.85 a share. Thursday’s short-lived highs represented a 2,500% increase in less than a month.
Where Short Sellers Came in
This brings us to the second thing you need to understand about what’s up with GameStop stock, which is how short selling works.
When you short a stock, you’re essentially borrowing it without really buying it, betting it will go down. That’s what a lot of big institutional investors started doing with GameStop stock.
Suppose Company XYZ’s stock is trading for $50, but you think it’s a loser of a stock. You could simply avoid what you think is a bad investment. But you could also try to make money by shorting XYZ stock. Or at least you could if you were a deep-pocketed Wall Street investor. Most brokerages have pretty strict rules about who’s allowed to take short positions.
If you shorted XYZ, you’d borrow it and then immediately sell it to someone else at $50. Suppose you’re right and the price plummets to $20 a share. You’d then buy back the stock you’d sold for $50, but you’d only pay $20 for it and give it back to the original owner. You’d walk away with $30 profit.
But what if you’re wrong? There’s no limit to how much you can lose. If the stock climbs to $100 or even $1,000? You still have to buy it for $100 or $1,000 and return it to the owner to close out your position.
This week, GameStop became the most heavily shorted stock on the market. At least two huge hedge funds bet against GameStop with short positions. One hedge fund tweeted that people buying GameStop shares are “suckers at this poker game.”
Your best bet for making money over the long term, regardless of market swings? Dollar-cost averaging.
How Regular Investors Fought Back
That didn’t sit well with a lot of regular investors. Some saw legitimate reason to invest in the stock, including the addition of three prominent board members, one of whom is Chewy’s Cohen. But plenty were simply fed up with Wall Street and its reputation for looking down on ordinary investors — or “retail investors” in stock market parlance.
Some joined together, many using a reddit group called r/WallStreetBets, to deliberately drive up the price by buying more and more of the stock. It’s called a “short squeeze.” Stocks issued by other troubled companies, like AMC Theatres and Blackberry, experienced a similar phenomenon this week.
Remember: When you’re holding a short position in a stock, you can lose an unlimited amount of money in theory. If you’d shorted a stock and it kept shooting up, you’d probably panic. You’d scramble to buy shares as quickly as possible before they soar even higher.
Hedge fund managers aren’t that much different from you and me there: Those two big hedge funds that shorted GameStop rushed to close out their positions. The cost of betting against GameStop? More than $5 billion, according to estimates on Thursday.
Meanwhile, prices continue to fluctuate to extremes as investors jump in or cash out. Robinhood restricted GameStop trades on Thursday, then said they could resume Friday — which is part of the reason that GameStop rallied after hours. Or at least it was as of 5:41 p.m.
The third thing you need to know about GameStop in January 2021 is that whatever you just read is already completely out of date.
3 Lessons Regular Investors Can Learn From GameStop
Watching the GameStop saga play out has certainly been thrilling. But as much as this may feel like a win for the little guy, let’s not forget that in teaching a few megarich hedge funders a lesson, a lot of average people also lost money as the drama unfolded. Here are three takeaways for the rest of us.
1. Nothing has changed about GameStop’s value.
Some traders were able to make huge profits on GameStop’s meteoric rise. But despite all the unbelievable price swings, absolutely nothing has changed about the company’s actual value. It’s still struggling with the shift to digital gaming and remains deeply in debt.
When you buy stock in a healthy company, share prices will rise and fall. But short sellers and Reddit users won’t be able to drive the wild price swings we’ve seen in the past few days.
2. Buying cheap stocks is incredibly risky.
In case the unbelievable 2,500% returns you could have achieved in less than a month have piqued your interest, take a step back. That would require the ability to perfectly predict the market, something absolutely no one can do.
Before you scour penny stocks in hopes of finding the next GameStop to make a quick profit off of, consider the far likelier outcome of investing in a dirt-cheap stock: that you lose 100% of your investment.
3. Getting rich is boring for most people.
Ask anyone who’s built wealth and wasn’t born rich how they did it. They probably won’t tell you a story about taking short positions or buying $2 stocks.
Most likely they’ll tell you that they started investing early. They’ll stress consistency and long-term investing over day trading. And no matter how they feel about Wall Street, they’d no doubt tell you not to make investing decisions based on emotion.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected].
