GameStop. Hedge Funds. Wall Street Bets. Robinhood. What was it all?
You can read about the story pretty much anywhere at the moment, so we'll briefly run through it and then take a look at
a few other aspects we think are important.
In the last week of January, the price of stock in GameStop (NYSE: GME) – an ailing brick-and-mortar video game retailer, very suddenly skyrocketed. Many locals may not be familiar with GameStop but they might have seen its subsidiary EB Games in Napier & Hastings.
Shares in GME rocketed nearly 2000 per cent in the last three weeks, closing high of US$347.51 on January 27, touching intraday highs of over US$450, giving GameStop a market cap of nearly US$17 billion.
Nothing happened within the company to drive the increase; its fundamentals remain unchanged. It was purely a speculation bubble – but with a twist.
A group of people on 'Wall Street Bets', a subsection of an internet forum called Reddit, essentially took a dislike to the fact a video game retailer called GameStop was being shorted by a group of Wall Street hedge funds.
Shorting is an investment tactic where a larger investor, like a hedge fund, makes money on stocks for which the price is falling. It is called short selling (or going short).
In the case of GameStop, some Wall Street Bets users argued that the stock was actually undervalued, and the hedge fund shorting was unwarranted and unjust. This snowballed into many Wall Street Bets users deciding to buy GameStop stock to push the price higher, hopefully forcing hedge funds to exit their short positions at a significant loss.
As of Friday, February 5 at 8.50am NZDT, the stock price has been cratering by 88 per cent and traded at US$59, giving GameStop a market cap of US$4.19 billion.
The new apps and trading platforms that have arrived on the scene over the past few years have been termed as democratising financial markets. They are low cost (some even free) and they are targeted at younger investors.
Not paying money to trade may feel good, but nothing is free so then the question becomes who is paying? It's very complex.
These el cheapo brokerage apps and platforms that are being pushed at young investors aren't free. They all come with a cost. If you cannot see the risk, then you haven't found it yet. If you can't see the cost, then you haven't found it.
In the case of Robinhood, its customers' trades were routed through a hedge fund called Citadel. It paid Robinhood for this privilege, meaning it makes the market, taking the order and then flipping it to collect the spread. Robinhood doesn't charge its users brokerage, but the users pay through Citadel cutting ahead of them, along with the collection of their data.
This is one of those areas where people who hate paying can feel like they aren't paying because there's not an itemised line of how much this process costs them.
The other issue, brokerages and platforms cost money to run. There are transaction costs as money is held to settle and a lot of the trades are done on margin. Brokerages require liquidity as credit is needed.
Robinhood and other brokers were overwhelmed by what took place and had to halt trading. At one point, users could only sell their positions, which caused outrage. There have been claims of conspiracy, but no one should be surprised when cut price platforms deliver cut price results.
Cut price broker systems and their liquidity position likely couldn't handle the situation as they're not set up for what is occurring.
A key part of any investment is understanding custody risk. Financial Advisers act on behalf of investors making decisions, not just in how we invest, but where investments are held. We ensure investors have custodians of the highest quality.
The DIY crew are often looking for the cheapest option. It's great to say you pay nothing. And nothing may ever go wrong, but these are concerns that you want eliminated.
Brokerages and custodians have failed in the past and they are a nightmare for investors.
Given what we were talking about last week, getting caught in a wave of emotion is dangerous.
There were plenty of stories in the media and online forums suggesting this was a revolution and revenge. People talking about never selling and not caring if they lose money is ridiculous.
Like always, there will be a select few who make out like bandits. These people will attract the media attention and get interviewed about their gains. Those investors who racked up large losses thinking they were part of a movement will realise there will be no adulation for their efforts and will be quickly forgotten. That was real money they lost.
Does any of this matter to you?
Not really. It's an interesting story, but if you have a boring aka sensible portfolio, it's just another sideshow on the investing journey. As far as a populist revolution and the little guys getting back one on Wall Street? That happened with the first retail index fund in the 1970s!
· Nick Stewart is an Authorised Financial Advisers and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
· This article is prepared in association with Mancell Financial Group, Australia. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz