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The madness and power of crowds

Most readers should have been following how the GameStop saga has unfolded on US stock markets. It is a story of a company called GameStop – whose stock is rose 100-fold because of herd-behaviour. The fascinating thing is that the share price was propelled by unsophisticated retail investors that “coordinated” a buying spree to hurt short sellers on Wall Street (mostly hedge funds). Piggy has been doing lots of research on the saga and thinks that for one to fully appreciate the story, there is need to take note of the main actors in the drama.

The Main Actors

First and foremost, there is GameStop Corp, a video-game, consumer electronics and gaming merchandise retailer that has been hit hard by the coronavirus pandemic. The company is the world’s largest video game retailer, operating 5,509 retail stores throughout the US, Canada, Australia, New Zealand, and Europe. The company declined during the mid-late 2010s due to the shift of video game sales to online storefronts and failed investments in smartphone retail. Second, there is the Robinhood App which has been dubbed “the Facebook of stock trading”. The app now has over 12 million users and has essentially ushered in a revolutionary democratization of financial trading as it has increased the participation of individuals on stock markets. Robinhood offers commission-free stock trading and its revenue comes from interest earned on customers’ cash balances, selling order information to high-frequency traders and margin lending.  Third, there is Reddit and a message board called r/WallStreetBets. Reddit is a social news aggregation, web content rating, and discussion website. Registered members submit content to the site such as links, text posts and images, which are then voted up or down by other members. Posts are organized by subject into user-created boards called “communities” or “subreddits”, which cover a variety of topics. r/wallstreetbets, also known as WallStreetBets or WSB, is a subreddit where participants discuss stock and option trading. With this, readers should buckle up because this is one of the craziest stories in investment history!

The Short Squeeze

A short position is a bet that a share price will fall. Hedge funds such as Melvin Capital, Point72 and Citron Capital had taken short positions on GameStop given that it was facing significant hurdles because of the coronavirus pandemic. However, users of the Reddit forum Wall Street Bets (mostly day traders) banded together and managed to ramp up some beaten-down stocks, such as GameStop, Blackberry, and AMC Entertainment Holdings, besting some short sellers in the process. The point here is that Gamestop was trading below USD20 at the beginning of the year. However, the price rose sharply and shot up more than 100% reaching an all-time high of USD347.51. The phenomenal stock price movement drew the attention of everyone including Elon Musk, the world’s richest man. The result has been a short squeeze. This happens when short sellers of a stock move to cover their positions, purchasing large volumes of stock relative to the market volume. Purchasing the stock to cover their short positions raises the value of the shorted stock, thus triggering more short sellers to cover their positions by buying the stock. According to Ortex, short sellers lost about USD19 billion just on GameStop.

GameStop Share Price Movements up to end of Jan 2021

Source: Google Finance

GameStop Share Price Movements since the Beginning of Feb 2021

Source: Google Finance

Feasts and Famines

The financial markets landscape has completely changed as it has merged with the world of social media and a younger generation of traders who have been empowered by online platforms. It has also made some in this new generation wildly wealthy. In mid-2019, a Reddit user — known as “Roaring Kitty” on some social media accounts — posted a picture on an online forum depicting a single USD53,000 investment in GameStop.  Roaring Kitty — who is Keith Gill, 34, has now become a central figure in the stock market frenzy. Mr. Gill’s USD53,000 bet on GameStop soared in value to cUSD48 million. It is like the story of David and Goliath. The small and unsophisticated investors made absolute buckets at the expense of large and sophisticated hedge funds.

Of course, there are always casualties. The graphs above illustrate how the share price lost steam from its peak of USD347.51 and crashed well below USD60. More recently, the meme stock is back again and the gaming retailer’s stock is now priced at USD91.71 (up nearly 104% from the previous day). The recent jump in GameStop came after the company announced its CFO would resign to help accelerate GameStop’s transformation from relying on physical stores to an e-commerce sales model.

The madness of crowds

It would seem that US stock markets are in the grip of what Charles Mackay, a nineteenth-century historian of financial manias, called “the madness of crowds.” For almost a year now, investors have been bidding up shares in companies like Tesla, Shopify, and Snap to prices that bear little relation to the actual earnings prospects of the underlying companies.  Even big institutional investors have been riding the remarkable rise of mega-cap tech stocks like Amazon and Apple despite the obvious risks of concentrating their portfolios on a small number of winners. It is something like the dot-com boom that happened between 1998 and 2000 when hundreds of new internet start-ups held initial public offerings (IPOs) of stock and many of them saw their stock prices skyrocket. The Nasdaq exchange, where many of these stocks were listed, rose by about 220%.

It is also about the power of crowds

Piggy contends that social media is indeed playing a significant role in the democratization of trading and investing. It should also be highlighted that members of the Wall Street Bets subreddit are mostly young retail traders. The growing popularity of no-commission brokers and mobile online trading has also contributed to the growth of such trading trends. These retail investors on Reddit are not just targeting meme stocks like GameStop and AMC Entertainment but have also been banding together to push up the price of other assets, including cryptocurrencies like Dogecoin. The cryptocurrency has spiked more than 500%. The underlying reason is that social trading forums promote copycat behaviour. The sight of others making seemingly easy money is enough to persuade others to follow suit.

Key Takeaway from the GameStop Story

It is difficult to predict when and how the frenzy around GameStop will end. One thing for sure is that there will be winners and losers. There will also be serious casualties. That said, the positive is that the internet has revolutionised trading and investing. Piggy has received lots of inquiries from folks that have been finding it difficult to start investing on Zimbabwe capital markets. The common reason is the lack of knowledge on how the stock market works. Piggy has been promoting information sharing and idea generation through WhatsApp based social trading groups. The objective of the trading groups would be to encourage individuals to onboard various trading platforms such as C-Trade, ZSE Direct, IQ Option and Iron FX as a strategy of saving or preserving incomes. This new trend is very beneficial and can be used by new traders that would like to connect and receive ideas directly from other traders. It is a great way to generate value by sharing ideas. Individuals looking to be part of these online communities can contact Piggy.

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