You’ve probably heard about Gamestop by now, and I thought it could be helpful to explain what happened in regular people terms. Gamestop is a company with stores that sell videos and gaming stuff. That is, unfortunately, beside the point here. Gamestop is a publicly traded company, which means its shares are traded on a stock exchange (NASDAQ in this case). People can buy and sell shares of Gamestop.
Let’s talk about buying and selling shares. Usually, or should I say, historically, people bought shares in companies they thought had a bright future and whose value would increase. If a person owned shares in a company and that company made a decision the stockholder thought would reduce the value of the company, the stockholder could sell the share. Pretty simple, right? Well, what happened last week is about as far from that antiquated notion as a modern car is to horse and buggy.
Large stockholders decided they thought Gamestop’s value was going to go down A LOT in the coming months/years. They decided to take on a SHORT position. What does that mean? Person A BORROWS shares from a large broker (let’s say 100 shares), sells the shares at the current price (let’s say $10/share) and waits for the price to go down. Person A made $1000 (sold 100 shares at $10/share) and OWES the broker 100 shares. Then the price goes down to $5/share and the short seller buys 100 shares at $5/share to give back to the broker, spending $500 and keeping $500 in total profit for Person A.
Short sellers help the market overall by acting as a counterbalance to “irrational exuberance,” but the problem with Gamestop is that BIG short sellers were waiting for the price to reduce to buy back LOTS of shares (in fact, more shares than the actual number of shares that exist), but the price NEVER WENT DOWN. The short sellers were stuck OWING the broker LOTS of shares and they had to buy them back at a MUCH higher price.
Sure this is fun as “little guy kicks big guy’s ass” story, but the harm to the market and therefore regular people’s retirement funds is that all this “gaming” of the stock does NOT HAVE ANYTHING TO DO WITH THE COMPANY ITSELF. The market share price of a stock is supposed to reflect the fundamental health of the company, its future and the health of its sector. The shenanigans that went on last week for Gamestop do not have anything to do with the basic health of Gamestop or its sector. Regular investors who don’t want to “kick the big guy’s ass” or “short the stock” don’t know if Gamestop is a fundamentally good buy or not. The ACTUAL health of the stock and the sector it belongs to is clouded by all this.
If we don’t have any understanding of fundamentals, what do we have? Gambling, gaming and guessing. Be careful. Don’t get swept up in the idea of easy money. There could be non-professional groups who may artificially inflate stock prices, but the regular person cannot know when or how. Stick to long-term investing with solid diversification and low fees.