Unless you’ve been living under a rock, you’d know that there’s been a massive frenzy over a stock that rallied over 1,900% in the last few weeks.
I’m talking about GameStop.
A gaming company which was $4 last year and today (as I’m writing this) is over $360 per share. That’s over 8,000% growth.
In fact, my inbox has been flooded over the last week with questions, about what happened with this phenomenon.
Funny thing is, I’m getting questions from not only investors and traders but also from Facebook friends, Virtual Reality pals and even acquaintances who’ve never even bought a share before.
And so, in this article, I’m going to explain what happened to the company, why you should worry and where it’s heading…
Let’s go…
GameStop WAS one of the victims of COVID-19
GameStop is your everyday brick-and-mortar company. It sells video games, consoles and accessories.
It was one of the victims that was hit hard by the COVID-19 crisis.
In fact, last year, the share price was trading under $4. And since then, the fundamentals were looking bad.
Not only was it facing internal issues, it was also competing with major gaming companies that started to offer their games online.
So it was basically like Kodak was when digital cameras came out. Or Blockbusters was when people turned to online i.e. Netflix.
GameStop just didn’t have the speed to evolve, move online, they were suffering from heavy losses and were closing stores.
And massive hedge fund companies like Melvin Capital and Citron, thought it was a great opportunity to short the shares in the hopes that the price would drop and where they can profit.
And so just a month ago, the hedge funds shorted the share at around $15 in the hopes that the price will drop.
Even Citron Managing Partner Andrew called GameStop,
“an old school, failing mall-based video retailer.”
Boy, I’m sure they regret every decision to short this underdog.
Before I continue, you need to know what shorting or ‘short-selling’ means. If you do know then you can skip the shaded area…
What is “short-selling” and how do you profit?
Most investors follow the traditional ‘buy low, sell high’ share investing approach.
This is where you’ll buy a number of shares at a low price with the expectation that you’ll sell them at a higher price for profit.
‘Short-selling’ is the opposite practice.
Shorting is simply a bet that a company’s share will drop in price, and so they will sell shares they don’t own.
How?
Well, short-selling is where you’ll borrow a number of shares from a broker and sell them into the stock market at a low price.
You’ll then bet and wait for the share price to fall even lower, where you’ll re-buy the shares back, return them to the broker, and pocket the profit.
In other words, it’s where you’ll ‘sell high, buy low’.
Here’s where the danger comes with ‘short-selling’
What if you sell high, borrow the shares from the broker, and the share price decides to rocket?
Now you’ll have to lock in a loss and buy them back at a higher price than what you sold the borrowed shares at.
There are two dangers with shorting:
There’s potential for unlimited losses
When you buy shares the lowest price it can go to is 0.
When you short-sell shares, the share price can go up 100s, 1000s of percentages and higher.
This means your loss potential is unlimited when it comes to shorting.
There are a limited number of shares!
This is also a major problem when you go the ‘short-selling’ shares approach. We know that major hedge fund managers took on massive short-selling positions.
So many that they sold more shares than there were shares in GameStop.
And so they might have covered a bunch of their short positions and taken the knocks.
But what about the rest of the shares that they can’t buy back, because there are not enough shares?
Now they’re incurring billions of dollars of losses. So much so, I hear the hedge funds are asking the governments to help bail them out.
Melvin Capital even asked for a $3 billion bail-out.
That’s why world-wide, many brokers have stopped allowing traders to short-sell GameStop. Not only to protect their asses but also because there aren’t any more shares to short.
And now world-wide, hedge fund managers can only wait and hope for the share price to drop where they can hopefully salvage some of their losses.
But let’s go back to the question I’m sure you’re dying to know the answer to…
How the heck does a company like GameStop rally over 1,900% in under one month?
Well, believe it or not…
According to the media and news – social media and demand lead to the insane rise.
After hearing about the Hedge Funds decisions to short-sell GameStop, the traders on Reddit decided to go against the hedge funds and buy buy buy…
In fact, in a subreddit forum called r/WallStreetBets (WSB), with over 3.5 million members run by “DeepFuckingValue”, said that the share price is undervalued.
This subreddit forum is known as the “4chan with a Bloomberg Terminal,”.
Basically, a huge number of people who like to gamble on the market with their own way of thinking, culture and thoughts…
They are even known as the ‘degenerates’. And so with GameStop they managed to convince each other to buy GameStop stocks and call options and go against the big hedge funds…
This frenzy created a sheep like strategy where everyone just bought more and more shares.
Take a look at some of the comments…
And now that mass buying is taking place, without looking at the company’s fundamentals, you know what happens.
The share price will continue to pump and the short-sellers will get squeezed out of their positions, including hedge funds.
This is also known as a ‘short-squeeze’.
And worse yet, every short-seller who shorted more shares than actually exit, wouldn’t be able to close their positions and cover their losses. Why? Because the extra shares don’t exist!
And now Redittors on r/WallStreetBets and many other traders and investors are holding onto their stocks and are not willing to let go yet…
So is this legal and who’s going to jail?
Right now, this is all under investigation and we don’t know the full details.
But I can tell you that many hedge funds and traders will go bankrupt.
When it comes to WSB, I don’t believe they are manipulating the market as they are all posting publicly without any form of inside-information. We are still yet to find out if there was some form of illegal collusion practices.
But right now, as I understand it, they are doing what betters, gamblers and traders do all day and every day.
Speculate and bet on potential moves.
But there is a bigger issue that’s lurking, when the dust settles.
This sets a precedent for the next “rubbish” company to rocket over 1,000% because a social community hates smart money.
They want to bet against the big companies rather than basing their decision on the underlying value of the companies.
And if this is all legal then, I hope that hedge funds, brokers and market makers will put security measures in place to protect not only themselves but their clients portfolios too…
They need circuit breakers, or safe applications (or insurance policies) to avoid bankruptcies in the future…
Anyway, that’s a conversation for another day.
Right now I’m sure you’re wondering what I’m doing with Game Stock and did I get in?
Let’s take look at the chart.
Why I expect a 56% crash with GameStop based on one simple reason
In the daily chart we can see that in one day the market price gapped (jumped) from $150 up to $354…
This means, if you were a short-seller and you had your stop loss between $151 or up to $353, it would have jumped past leaving you in your position at a HUGE loss.
And so, if you did manage to get out – let’s hope you didn’t have a big position to begin with relative to your portfolio.
Going back to the analysis… Normally, when a share gaps up based on no real fundamental (news or company related) information, there is n extremely good chance that the price will come down.
In all my years of trading, I’ve seen my own statistical analysis of over a 75% chance of a gap to close.
And if this is the case, GameStop could drop in price quite quickly back to the $150 mark.
This could happen in the form of a bubble where investors start selling their positions. This gets into panic selling, which cause a fast and furious drop in price.
As traders, well we can’t really do anything because most brokers have cut the option to short.
But even if they had the option to short, I personally don’t like the gamble of betting where a price will go based on sheep mentality.
I prefer to follow a strict and consistent trading strategy, as I’ve done for the last two decades.
I would like to conclude with…
Five warnings and lessons based on the GameStop debacle.
Warning #1: Stop loss is a must Always set a stop loss or ideally a guaranteed stop loss with your trade
Warning #2: Forget hindsight Never look at hindsight when trading – these occurrences are extremely rare and almost never the same as the last.
Warning #3:Risk less Make sure you manage your risk position very carefully and only deposit a tiny percentage of your portfolio
Warning #4: Short-sell only top companies I only short-sell companies that are Blue-Chip companies that are not near bankruptcy. This way, there is a better chance that the market price won’t jump up or down with erratic percentages.
Warning #5: Don’t follow the crowd Follow your own proven trading strategy and don’t get sucked into the buying or selling based on what other people tell you to do.
