The start of 2021 came up with a very interesting saga where a few stocks listed on US stock markets became a real life casino. This blog post intends to look into the recurring investor behaviour which once again appeared in this case. The post does not aim to go into the details of how the events unfold as a lot is out there in the public forum for interested minds to read.
What Happened in Summary
Group of interested retail investors (quite a few) were discussing on an online site ‘Reddit’ about a stock ‘GameStop’ and that it has been ‘Shorted’ by some hedge funds. They discussed upon the opportunity to make money by buying them together, i.e. unity is strength. This resulted in a lot retail investors buying huge quantities of this stock both in cash & derivatives market, pushing up the stock price exponentially.
The more the price moved up, the more buying came in. See the image below on how the price zoomed up from sub $20 in early Jan to ~$30 on 13 Jan, $65 on 22 Jan, ~$150 on 26 Jan, and a peak price at $350. On 28 Jan, it briefly came down to ~$200 and then back to ~325 on 29 Jan 2021. And finally the buying slowed and the prices started to fall from the cliff > to ~$50 on 4 Feb. The chart below shows the dramatic bubble which was blown and burst within a span of three weeks.
While the event was unfolding, I was rolling my eyes to see the stock price double / trebling up each day. I was wondering how many first time small investors & seasoned investors were jumping to buy this stock to see instant gratification the same / next day. With each day’s gain, my tummy was churning thinking about the potential correction, which would turn the tables back towards the race to ‘0’.
The data perhaps would never be out, but I feel there would be several 100’s of thousands of investors who may be scarred for life. They would have pledged their entire life’s saving to even borrowing from friends / families to enter into the casino being created by their united lots. The Market Gods would be watching this game being played and wondering that who would be having the last laugh. A few sad stories spilling on the web are below
Sagas like GameStop occurs regularly, in different asset classes and geographies. In most of the times, they have the same traits and I thought about calling a few of the top learnings which could perhaps help in avoiding the trap.
When it comes to investing, if it is too good to be true, then it is more likely that it is not true. One must understand the fundamental merits of an investment asset before entering into it. If one doesn’t understand the same, it is best to consult an advisor or rely upon professional fund managers. Still, it is better to stay away and miss the temporary opportunity to make money, rather than loosing whole life’s saving. A few of my US friends / contacts called me up asking my view on entering the GameStop in the last week of January. My view was to shut the trading screens for a few weeks and then see where it lead to. It was clearly a frenzy driving up the stock price of a loss making business. Didn’t make sense to me then. And it didn’t even take a few weeks for the markets to put a nail in the coffin.
Frenzy Movement in Prices
What goes up sharply, in all likelihood comes down to normalcy, sooner or later. Slow & Steady wins the race. I believe that these two statements also apply to business valuations in stock markets. Any frenzy buying in most cases gets toned down as time progresses. When sanity prevails, the froth (madness) gets removed. This is when one could take a more informed decision on the fairness of the valuations. In many cases, slow & steady or in other words, boring movement of stock prices is more reliable and ‘relatively’ a more sane / safe price for a business. Even the most stable and safe businesses get impacted by short term frenzy buying, resulting in excessive stock price movements. But sooner or later, sanity prevails. So when I see frenzy movements, I take a step back and relax.
Derivatives Are Leverage Instruments
Futures and Options (F&O) were perhaps invented for hedging of risks. Speculation / gambling found its way in and investors (speculators) started using them as an investment position rather than to hedge their risks. The most attractive proposition here is > F&O gives investors multiple times exposure to stock positions with same amount of capital. For example, if I have Rs. 1 lakh as capital to invest and I invest it into a stock / fund. If my investment goes up by 10%, I will gain 10,000 on my Rs. 1 lakh capital. But what if I invested it in the Futures markets ? The same 1 lakh may give me an option to take investment position of say 10 times of 1 lakh, i.e. 10 lakhs. Now if the markets move up by 10%, I may gain 10% of 10 lakhs, i.e. 1 lakh return. This would sound 100% return on my capital of 1 lakh – sounds great ! But what if the markets move down by 10% ? My entire capital will be wiped off. Generally F&O positions are taken by investors are for short durations, say ranging from a month to a few months. Investing in equity markets with such a short duration is nothing short than a ‘gambling’. And taking investment positions via F&O markets could be best termed as investing way beyond ones means.
Rightly Buffett termed F&O as weapons of mass financial destruction.
Materiality in Speculation
Lets say if one still wants to game in ! After all many would love to participate in the opportunity of making quick bucks, despite of knowing that it may not be an investment option which meets the checks of being a sound fundamental option. So if one really wants to dive in, this shouldn’t be beyond a pre-allocated percentage of one’s kitty which they would be okay to see it wiped off. And please, play with your own money and not on borrowed money of near & dear ones. It would be very difficult to digest the guilt of wiping of that hard earned retirement capital of your loved ones !