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13 February 2021
In the past few weeks, news outlets have been full of stories about GameStop and other stocks going through the roof thanks to massive buying pushes coordinated online. There have been just as many stories about these stocks later crashing to Earth.
Should you get involved with these kinds of bets? For many, it's tempting.
GameStop was the biggest of the recent stories, which have all revolved around so-called short squeezes. Short squeezes happen when a stock's price jumps higher, and traders who had bet that it would fall must scramble to buy more shares in order to avoid even greater losses. This self-reinforcing dynamic pushes the stock ever higher, until the bubble bursts and the stock price plummets.
The GameStop saga began in early January, when an online community of investors in a Reddit forum turned their sights to the videogame retailer, which Wall Street hedge funds had heavily shorted, or bet against. Over the next few weeks, the so-called Reddit army of small investors, joined by some big, sophisticated players, binged on GameStop shares, pushing their price from $17.25 to near $400. The craze also targeted movie theater chain AMC, which shot from around $3 to nearly $20 in the course of a few days. In the most recent example of the trend, shares of cannabis company Tilray more than doubled, to $64.
In all of these cases, the stocks' run has resembled a toddler's sugar rush, followed by the inevitable crash. Within a matter of days, Tilray lost all of its recent gains. Likewise, AMC shares plunged from around $19 to $5.50. And GameStop dropped from nearly $400 per share to around $50.
Yes, there were winners, who got in early and sold before the crashes. But these short squeezes produced a lot more losers, who bought in as the stocks were running up, only to ride them down again. As usual, the deep-pocketed, sophisticated Wall Street investors likely made out best. As in a casino, the house always ends up as the biggest winner.
You can be sure there will be more GameStop-type situations going forward. There will be lots of hype, and stories about regular people making enough of a profit to pay off their debt or buy Teslas. But short-term trading is a zero-sum game, and someone is always left holding the bag—and the news media isn't interested in their stories. Another phenomenon you don't hear about is how often the winners, emboldened by their success, take more bets and wind up humbled.
The truth is that the short-term trading waters are full of sharks, super-smart professionals armed with sophisticated software, whose every waking moment is spent seeking out opportunities at the expense of amateurs. You can be sure they are raptly following the message boards alongside the do-it-yourselfers, perhaps even participating in them with an eye toward "pump-and-dump" schemes.
My strong advice is to not swim in shark-infested waters. If you're serious about building wealth in the stock market, make long-term investments based on stocks' fundamentals, such as revenue, debt, management and so on. There is always a way for patient investors to make money without taking on extreme risk. Please reach out if you'd like to discuss where the best opportunities for long-term investing lie right now.