What Does The GameStop Madness Mean For You?

Late January saw one of the craziest stock market runs ever as a collective of individual investors gathered together to make one of the greatest, most unbelievable trades we have ever seen.

It caused ripples throughout the market and made major news all around the world. Now, what happened exactly?

Snowcap Financial is here to break it down for you, and show you exactly how it impacts you and your retirement investing.

What happened?

A few people on Reddit saw that an outsized short position on the stock of video game retailer GameStop, and convinced a large group of other investors to join in and buy the stock to drive up the price. When the price started to go up, it caused a problem for those short positions and caused the stock price to skyrocket. Some brokerage firms like Robinhood weren't well prepared for such an extreme scenario, and stopped allowing traders to buy the stock, and chaos ensued. 

What is a short position?

When someone wants to bet against a stock, thinking it will go down, they can "short" it. Essentially, it is like buying the stock on credit. If the stock price goes down you can buy it at the cheaper rate, and then get to save the difference from when you borrowed it. If it goes up, you're obligated to buy it at a higher price, while paying the credit fees along the way. You can make as much as the stock falls, but there is unlimited potential losses as the stock price rises. 

What happened with GameStop?

GameStop had 140% of the total shares shorted, or borrowed, mostly from large hedge funds. These traders on Reddit saw it, and took advantage. They started to buy, and get other people to buy, raising the prices. When the price started to skyrocket, many were forced to buy the stock at the extremely high prices and take massive losses on their positions, in the billions of dollars. This is called a short squeeze. Short squeezes are not an uncommon occurrence, but examples this extreme have only happened a handful of times.

What did it do to the overall markets?

As many of these large investment firms had to take these massive losses, they were also required to sell many of their more successful long term positions to cover their debts. It caused many names to fall and the overall market indices to fall with it.

What will be the lasting effects of this?

There will probably less shorting in the future, certainly not to the extreme we saw with GameStop. With the public having more information and more transparency on these kinds of positions, firms will be more reluctant to have such outsized risk exposure. You could see more examples of traders collectively trading ideas and themes from online forums, though I imagine regulators will find a way to curb such extreme trade flow.

The markets themselves have stabilized and future consequences should be relatively small. 

What should I do with my investments?

Have a plan. While it worked for the early participants in the GameStop madness, there are people who bought shares at $400+ a share that not very happy right now with it closing at around $67 a share yesterday (2/06/2021). This is like gambling, it's not long term investing. You need to develop a long term strategy for your investments in solid companies and their stock, as well as mutual funds and ETFs that allow you disperse risk. Invest regularly and over the long term history tells us that you should be successful. 

What is the best plan for me?

Depends on a lot of factors, your age, how long until retirement, your risk tolerance, overall financial picture, etc. Your Financial Plan should drive that. That's where we come in!

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