In a matter of days, GameStop has gone from being a dying retail chain to the latest obsession of media and markets. Along the way, the GameStop saga has morphed into a lesson in American populism, an allegory of Main Street taking a pound of flesh from Wall Street.
To recap: Video game retailer GameStop was struggling to survive even before the pandemic struck, and Covid-19 only worsened its ailing condition. Hedge funds on Wall Street smelled blood and took out massive bets that the company’s shares would drop, maybe even to zero—so-called short trades or short positions.
Meanwhile, a group of stock market enthusiasts who congregated in an online chat room—Reddit’s WallStreetBets—came to the realization that they might just be able to beat the Wall Street guys at their own game. It took time, but they did just that, aided and abetted by commission-free trading platforms like RobinHood.
Much is being said about this unlikely story, and the drama will keep unfolding for some time. But there’s an immediate lesson to be learned from the GameStop saga: Investing isn’t a morality tale, and it’s not a game.
GameStop Brings Populism to Wall Street
One of the most notable aspects of the GameStop caper was how rapidly people sorted themselves into two groups. On one side, there were those who saw the members of the Reddit chart room WallStreetBets as a righteous force.
According to this narrative, the WallStreetBets traders were sticking up for GameStop and its employees, at risk of joining the ranks of the unemployed if hedge fund managers like Leon Cooperman were allowed to keep driving the stock lower and pushing GameStop into bankruptcy.
I’ve said it before to my friends who used to work in ToysRUs.#HedgeFunds bought these struggling companies not to save them but to make sure they worth nothing & file bankruptcy. It happened so many times.
They are doing it to #GameStop
My dear #WSBMOVEMENT, HOLD THE LINE!
— Mic and Me (@TheMicAndMe) January 28, 2021
The opposing narrative included the market professionals and the Wall Street titans—Cooperman and his crowd.
The professionals took to television and constructed a narrative that “retail investors” (a.k.a. regular people) were manipulating the market for their own gain and pushing the price of GameStop well above its “fundamentals.” After all, who could possibly believe that GameStop is as valuable a company as Delta?
Listening to irate New York hedge fund billionaire Leon Cooperman on CNBC right now lamenting people “sitting at home getting their checks from the government, trading their stocks.”
“This fair share is a bullshit concept,” he shouts. “It’s a way of attacking wealthy people.” pic.twitter.com/zFW6o1MFND
— Jake Offenhartz (@jangelooff) January 28, 2021
This dialectic was only heightened after zero-commissions online broker Robinhood restricted purchases of GameStop and a short list of other stocks recently popular with the Reddit rabble. Robinhood played to both sides of the debate, claiming both that financial markets had “become a voice for the voiceless“ while their move was “a risk-management decision.”.
This move prompted many, including politicians on Twitter, to claim the game was rigged in Wall Street’s favor. Why let big guys short companies in the first place? Someone, they reasoned, needed to stick up for the little guy.
Day Traders vs Goliath
Hedge fund executives aren’t a sympathetic lot, and they tend to make themselves look worse when they go on television to complain about the folks at home and their trades. The day traders of Reddit and WallStreetBets have a fraction of their money and clout—it’s truly a mob of Davids battling with hedge fund Goliaths.
But something is getting lost in the black-and-white debate: Day trading isn’t something the public should be rooting for. In many, if not most cases, day trading is more akin to gambling than investing. Research has shown that stock pickers can’t consistently deliver a higher return than an index with a broad array of companies like the S&P 500.
And when some do, even those who are professionals, usually it’s because they get lucky.
“University of Wisconsin professor Werner De Bondt estimated that more than 10% of stock mutual funds are likely to beat the average performance of the average equity fund three years in a row, just as a matter of chance (the author’s emphasis),” wrote Gary Belsky and Thomas Gilovich in “Why Smart People Make Big Money Mistakes.”
As humans, we’re endowed with a rich catalogue of behavioral biases that make us think that we’re smarter than we actually are.
Hindsight bias makes us overconfident about our ability to accurately predict and explain events. We always just knew this or that thing was going to happen—even if we didn’t actually predict this or that thing at all, or we were off by huge intervals.
We also don’t tend to remember our misses, or we chalk them up to dumb luck. Experimental subjects rate themselves as significantly better at predicting the outcomes of coin tosses—a totally random activity—than others making the same predictions. The subject tend to remember their successes and forget their mistakes. To sum up, it’s a game of “heads I win; tails it’s chance.”
Short Sellers Aren’t Always the Bad Guys
In the Battle of GameStop, the day traders have been celebrated for crushing the hedge funds who were betting that shares of GameStop would tank.
This particular form of trading—arranging so that you profit when a stock declines in value—is called short trading or short selling. To be sure, short sellers have never been a particularly popular breed. Napoleon reportedly once referred to short sellers as “enemies of the state.”
Trouble is, short sellers aren’t always the bad guys.
Michael Lewis’s book on the housing market and how it helped cause the Great Recession, “The Big Short,” told the story of a handful of gadfly investors who pulled off huge, lucrative short trades. They saw the huge bubble in home values in 2005-2006 and assumed it wouldn’t end well. Their trades didn’t make them heroes, but they were certainly not villains, either.
More recently there’s the case of electric vehicle company Nikola Corporation and short-seller Hindenburg Research. Nikola was a hot Nasdaq-listed startup that aimed to become the Tesla of long-haul trucking. Trouble is, its business turned out to be mostly hot air—Hindenburg Research exposed the company for being founded on empty promises and shorted its stock.
It’s worth asking: Didn’t Hindenburg save countless investors from making a bum investment in Nikola Corporation? Short trading isn’t always a black-and-white narrative.
The Lesson of GameStop
The Wall Street Journal recently profiled Jaime Rogozinski, the man who years ago created WallStreetBets but has since left the group.
The story describes how Rogozinski started the community back in 2012 because he was tired of being told not to pick stocks in online forums, and he didn’t really like the talking heads on television. So he crafted an online watering hole where like-minded people could congregate and take on the market. Rogozinski wanted to have fun.
That’s a problem.
Investing isn’t supposed to be fun. When you do investing right, you get rich slowly, via the gradual process of compounding value. It’s the phenomenon that explains why retirement investing works at all, and it takes a long time to make a real difference to your bottom line.
Take a well-diversified index fund based on the S&P 500. You can earn an average return of about 10% annually with an investment like this, if history is any indicator. It may not provide the adrenaline high of GME, but it minimizes the risk you arrive to the stock market party too late, buy high and are forced to sell low when a trading bubble inevitably bursts. This is the unlucky fate of many who bought into GameStop after the rally was already done.
And you can still enjoy the spectacle from afar. If you’re so inclined, pick a team, rage against the other side and revel in the denouement. The coronavirus has rendered much of what was once enjoyable moot anyway.
But don’t try to have fun with money you can’t afford to lose.