Video meme: The Battle of Gamestop - WSB vs. Melvin Capital (click picture for the video). Source: Reddit.com
Robinhood took money from the rich and distributed it to the masses. Only this time, it was the trading app, not the hero in green stockings.
Hedge fund Melvin Capital was down about USD 2 billion last week because it bet against the video game retailer GameStop (NYSE: GME) by shorting the stock. Retail investors, encouraged by countless posts on r/wallstreetbets (on the social news site Reddit), had piled into the stock and drove its price from around USD 20 at the start of 2021 to more than USD 65 on Friday, January 22. A Reddit user called “Deepfuckingvalue,” who declared GME a buy as early as 2019, purportedly made more than USD 7 million on call options bought for USD 50K. He was crowned in a meme; another meme (pictured above) celebrated the “victory” against Melvin Capital. Many Redditors declared that they want to add fuel to the fire by increasing or entering long positions. They eagerly await Monday’s opening for the battle to continue.
What is going on here? And what can we learn from it as investors?
Enthusiasm is contagious
Watching other people getting rich very fast is difficult to stomach for most people. It doesn’t hurt you directly, of course, if someone invested early in Tesla stock, Bitcoin, or any other asset that has performed exceptionally well recently, and that person is now wealthier than before. But for those who didn’t enjoy the same gains, it hurts the ego and creates a gnawing fear of missing out: FOMO.
As expected, newspapers featured a lot of stories about the army of newly minted millionaires. Being exposed to such stories, readers who missed the party inevitably start questioning their approach to investing and are tempted to jump on the bandwagon. Markets only go up, right?
This psychological pressure is dramatically increased by a relatively new habit of investors to share screenshots of their performance online, dubbed “gains porn,” akin to the glamorized visual presentation of food called “food porn.” Looking at such gains, even if they are unrealized and might evaporate overnight, makes a voice in your head whisper, “This could have been ours.”
YOLO as an “investment strategy”
“I consider YOLOing my retirement savings into GME,” one Redditor wrote. There has always been a line between investing and speculating, but YOLOing takes this to the next level. “You Only Live Once” is a rallying cry encouraging all kinds of brazen, fearless or “I don’t give a shit about the future”-kind of behavior, and going “all in” on a single stock with money earmarked for a faraway retirement is certainly true to form. Depending on how the stock price develops, this might turn out to be a phenomenal bet or just plain stupid. Apparently, there once was a guy who tweeted “YOLO” while speeding just before he crashed his car and died. When it comes to investing, where does such behavior come from?
I haven’t seen any data on the gender of the GME punters, but I’d bet they’re more than 90% male. Men are more inclined than women to take risks, a variety of studies have shown. Even more importantly: Male risk-taking tends to increase under stress. I’d argue that the global pandemic has proven to be a stressor for most of us and might have amplified a natural tendency in men to make big bets. Mixed with outsized gains that people are constantly exposed to — and the desire to stick it to boomers, the financial elite, or any other foe imagined or real — this appetite for excitement turns into a powerful driving force of herd behavior and increasing aggressiveness. It will be interesting to watch if the US government watchdog SEC will clamp down on the meme-makers as market manipulators.
I also think it isn’t a coincidence that GameStop is a well-known brand name in an industry that most young men are intimately familiar with. The bravery necessary to enter and hold a speculative position against all odds and in spite of critics (such as short-sellers) has been dubbed “diamond hands” by the crowd, which can be abbreviated to two emojis, and it seems that many want to show the world that they have what it takes to merit that moniker. “Hold. Buy. High five Odin in Valhalla,” as one user eloquently described this desire to win, no matter what the cost might be.
Should you buy GME?
The key takeaway message here is not if GME is a hot stock or not. Instead, if you want to keep your money and your sanity while trying to invest in a sustainable way, consider the following points:
Before investing, ask yourself this question: Do you think a lot about how your current situation will improve when you realize gains on the position you’re about to enter? If this is your driver to invest, don’t.
If you want to invest in a single stock and can’t tell off the top of your head how much profit the company earns, how its valuation (expressed as the price to earnings-ratio) compares to its historic average, and what the main risks to its business model as listed in the annual report are, don’t. Fundamentals aren’t dead.
If you play with the idea to use leverage to buy stocks or to buy options in view of achieving outsized gains, don’t. Options trading is not for you unless you’re a finance professional with a CFA, hedging a multi-million portfolio. (As the chart below shows, people don’t just ignore this advice, they’re doing the exact opposite.)
To quell FOMO, consider the following:
Stock market valuations have reached a record high, and bonds offer no alternative.
At some point, the central banks won’t be able or willing to add more money to the stock bonanza, and stock prices will decline.
Given this starting position, set yourself a modest but realistic goal, something like a 5% return annually over the next decade, not more. Let this goal dampen your risk appetite.
People will stop posting “gains porn” when the gains start turning into losses.
Don’t deceive yourself that you’re a long-term investor and that if stock prices collapse, you can just wait a bit until they recover. The Dow Jones Index only attained its pre-1929 crash levels in 1954. Even if the average stock “only” took 12 years to recover, that is quite a lot of time. Furthermore, as the financial crisis has shown, many investors will sell in the worst moment when the losses exceed their capacity to bear financial pain.
Thanks to D.Z. for the inspiration to write about GME!