• Dragostin Kozhuharov

4 Trading Lessons from GAMESTOP / wallstreetbets

In this trading blog post I will cover ‘Gamestop’ - unknown company for people outside of the US until weeks ago, it became the sign of a revolution in online trading when a reddit group called wallstreetbets began buying the stock and caused a short squeeze. The times retail traders managed to hurt institutional traders on such a scale are not many.


What happened?


A new executive member with experience in e-commerce triggered the initial move up in the stock. I doubt that many members of the reddit group wallstreetbets were thinking about short squeezes in the beginning. It was another bet on an underdog company which missed on e-commerce, and if it managed to change its fortunes, the it would pay off well.

With heavy short bets on the stock, the interest by media started growing, when the price rose enough to trigger a short squeeze for some hedge funds. All of this done by retail traders, although we can be certain that others took notice as well and helped the push. When a short squeeze is triggered, the speculators who are short, have to cover their position, by buying back the shares at higher prices than where they sold. When they start doing this, it escalates the price move to the upside as they are buying. The reaction by Wall Street was bad. Keep in mind that 9 out of 10 retail traders lose money. The funds got beat, but the crying on mainstream financial media by some professionals was amusing. Take the loss and move on. If anything they triggered more anger than sympathy - it became personal for wsb and for everyone who is against wall street and the establishment. Talks of collusion between members of the reddit group are nonsense. Most of these people don’t care at what price they will buy the stock and how much money they can lose. Yes, it’s irrational behavior, but if people in funds don’t understand by now that humans are irrational and markets aren’t efficient, I think this Gamestop situation is a good lesson for them.

Then the brokerage firms decided to get involved – limiting trading on stocks targeted by the reddit group. In my opinion limiting leverage trading and halting options trading is fair. It’s a risk both for the broker and for the trader. But limiting or halting buys of the actual stock is a concern. Is it manipulation? We will see what the regulators say, but I am sure that all of the brokers had a clause in their terms and conditions which allowed them to take this action.

A week later and as of writing today Gamestop is trading premarket below 60USD. The recent high was 483USD. We can see that not only hedge funds got hurt by the erratic price moves. I hope that most of the people who were buying at high prices were able to afford the losses which they incurred.


LESSONS


Lack of a trading plan


While it’s understandable that most of the ideas published in the group are high risk, or in other words gambling, it’s important to have a plan when you are trading/speculating. I read some of the posts in the group and I can see that there were a lot of people who understood what they were doing. They knew how the funds who were short were positioned, they knew that a short squeeze could occur. I think these people knew also when to get out and take their profits.


The problem was that a lot of people are in just to follow the hype. They got into the stock wanting it to reach 1k. They decided that they will buy and hold – no matter what the price is, no matter whether the price moves against them.

Most times when a move to the upside such as this occurs in any asset, it’s followed by a correction.


I talked with a friend of mine who got in at around 230USD per share. He said that he wanted to hold for a bit to see what will happen. All I had to do was say – ‘Do you have a plan when to get out?’. After not receiving a concrete answer from him, I said that maybe he should create one.


He sold his stock within two days managing to get a small profit right before it crashed.


To summarise this point – have a plan. Are you entering late and exposing yourself to people who got in very early and will now book profits? What is the reason for you to get in? Nothing apart from ‘I want to stick it to Wall Street’? Maybe you should think of doing something else with your money. Or just put in a very small amount which won’t make you lose sleep.


We are irrational


There are people who bought this stock for one reason only – I want to punish wall street. They didn’t care at what price they bought, and they don’t care if they will lose money on the trade in the end. This is not rational behavior. Any trader needs to be aware of this, as they may end up on the wrong side of an irrational crowd. In the words of Keynes – ‘Markets can remain irrational longer than you can remain solvent’. In the gamestop case it’s more applicable to the hedge funds who were short. Yes, you were right, but at the wrong time. In the end it’s always more important to make money than to be right.

Shorts-sellers

This one is aimed at people who hate short sellers. People who short sell assets aren’t always bad for markets. Often times they help to fix mispricing and sometimes point out frauds. Remember that book/film called ‘The Big Short’? I am sure that most of you were cheering for the guys who were short rather than the banks who caused the crisis. Going on crusades against short sellers isn’t always good. That would be especially true when they have a valid basis to be short on a particular asset.


Another point here is to remember that it’s always harder to be outright short than long. This has to do with human nature – we are by nature more optimistic and this can be observed in markets. When we are in a bull market, the pullbacks are not as extreme, as the pullbacks to the upside in bear markets. Also, the risk to the downside on most assets is limited, whereas the risk for short sellers is unlimited in theory.


Problem


The last lesson is more of a problem. The group in reddit is popular now. This raises the problem that anyone can go in and put trade suggestions hoping that members will join in. Whether the moderators have a good way to deal with this, I am not sure. Ask yourself the following questions – Who and why is posting this idea? Do I have the skills to validate whether it’s a good opportunity or not? Even if you can answer these questions, be careful when you go looking for a trading idea.


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