Every once in a while, there’s investment news that captures the attention of the general public. In addition to being entertaining, there are usually lessons we can learn from those stories. But the education value might not always be obvious from the flashy headlines.
An oversimplification of the GameStop and AMC stories is what’s called a short squeeze. An investor shorts a stock; in other words the investor borrows a stock, sells it, then buys it back to return it to the investor who loaned the stock. This strategy is used when this investor believes that the price of the stock will go down. In current news, some hedge fund managers — we’ll call them HFMs — looked at the business and financial fundamentals of GameStop and AMC, and decided to short the stock. It made sense; after all, GameStop is closing stores and AMC is hurting since people aren’t going to movie theaters during the pandemic.
HFMs have to provide to the public what their holdings are. And several individual retail investors who use online trading platforms — we’ll call them IRIs — decided to buy those stocks in large volume, driving up the price. Thus, the “squeeze” part of the short squeeze. So now HFMs will have to buy shares at the inflated price to honor their short contract, and the IRIs are happy to sell at that price.
Technically, a short can have limited profit but unlimited risk. In other words, you could have to buy shares at a market price that’s exponentially higher than what you sell it for. If the one who did the short is an HFM, that might be possible, but quite expensive.
Some have heralded this event as a David and Goliath event, which it might be. But let’s remember that Goliath killed a lot of Philistines before he was felled by David. There might be some regulatory oversight that comes out of this event, but now that it’s happened, it might also change strategies that HFMs use.
The IRIs who bought stocks with the assumption that the HFMs would probably have to buy from them made some good money in some instances. But if something had gone wrong with the strategy, they might have lost some or all of their investment. What would have happened to their investment if the company had declared bankruptcy?
An individual investor might make a great return with a situation like this. But it’s not a good strategy for serious long-term investing. The possibility of little return or a loss of the amount invested makes it an interesting gamble, not a consistent investment strategy.
If you have enough emergency savings to meet your living expenses if you lose a job during your working years, you have enough in long-term savings to meet your needs in retirement, and you aren’t using either of these for an investment gamble, enjoy the excitement. But if you lose your investment, no whining allowed.
Linda Leitz is a certified financial planner and can be reached at linda@peaceofmindfin.com.
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February 07, 2021 at 02:00PM
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Linda Leitz: GameStop strategy a risky one for individual investors - Colorado Springs Gazette
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