What happened with the stock markets, and what is the connection with GameStop and Reddit?
GameStop has become a favourite on Reddit’s WallStreetBets forum. The 8 million members of the site are mostly very short-term, young and anonymous speculators. These investors took the stock price from US$4 a year ago to over US$400 in January.
At the same time, hedge funds carried out short1 trades in GameStop stocks and other stocks popular with forum members. This situation led to forced liquidation of short positions2 and forced hedge fund managers to buy the shares at a much higher price.
1 Short selling is when an investor borrows shares of a company and then sells them in the market. In this case, the investor often expects to redeem the shares later at a lower price.
2 Forced liquidation of short positions occurs when the price of a stock rises, forcing investors who have shorted the security to buy it to avoid even more significant losses.
Was Reddit’s user group policy too risky?
Some Reddit platforms did well, but GameStop’s stock fell sharply in early February.
“It’s amazing how easily the price of a relatively small stock can go up when there’s excessive trading,” said Kathrin Forrest, portfolio manager at PMSLinc Asset Management. However, one needs to consider how things evolve when investors move on and rush out. »
For most investors, chasing volatile stocks is not a good strategy. Indeed, it involves significant risks and requires close monitoring.
Many portfolio managers prefer to take the long view: buy and hold companies with solid balance sheets and positive outlooks. Doing so requires critically analyzing the value of the action and asking questions. For example :
What are the company’s current and projected profits?
Does the product or service offered by the company have a unique and lasting benefit that it can protect?
Does the company operate in a growing industry?
If the answers to these questions are consistent with the stock price, it could be a good investment. Otherwise, there is a greater risk of losing the money invested.
How did Redditors speculate with GameStop?
What Redditors were doing with the GameStop action and a few others in late January was considered speculation.
They were interested in stocks that were not expected to perform well and bet on their price going up based on their social media popularity.
“These are typically stocks that have seen a large increase in price, daily trading volume and options trading, but whose underlying fundamentals have not seen any significant change,” Ms Forrest explains. Stock prices were going up for no good reason other than artificially inflated demand. »
Is speculation a bad strategy?
Speculation is not a new or even unusual activity. Think particularly of the technology bubble of the beginning of the year 2000 or the tulip crisis in the Netherlands in the 17th century. Although some people have become wealthy, many have lost everything.
You should also know that speculation is not always considered harmful. Some investors with large portfolios spend a small amount investing in young companies that:
have promising ideas or own assets in the resource sector,
seek to profit from highly volatile stocks.
As speculative investments carry a significant risk of loss, this is not a common strategy.
What will happen now?
This example of speculative trading in GameStop stock caused some market volatility. It also arguably made investors a bit more nervous about the future. But most investors who hold equities (e.g. in balanced or equity mutual funds) experience short-term fluctuations in their portfolios when volatile markets.
If your goals haven’t changed and your portfolio is diversified*, you don’t need to worry about market volatility.
(* A diversified portfolio contains a variety of investments – equities, fixed income securities, commodities. These investments react differently to the same event. Indeed, this
