When GameStop’s stock price surged from $17 to $483 USD within three weeks, only to fall dramatically to $50 USD, it laid bare the risks of day trading and following social media investment trends.
Individual traders, known as retail investors, banded together via social media forum Reddit to invest in GameStop stocks - not only to make money, but to take down the hedge funds who had shorted (bet against) the stock.
Because the underperforming game company had been shorted, when the share price surged, the Wall Street giants seemingly suffered large losses, requiring capital infusions of billions of dollars.
But in the end, it was many retail investors who lost tens of thousands of dollars when American trading app Robinhood restricted trades on the volatile stock.
New Zealand investors also jumped on the bandwagon and approximately 10,000 Sharesies users (around 3% of its investors) were trading the stock, with the average trade worth $180, Co-Founder of Sharesies Leighton Roberts told REDnews.
“It was one of the largest media and social media stories we’ve seen and at Sharesies we saw three groups of investors involved:
1. The group that was fully on board with the social purpose;
2. The group that just wanted to make money;
3. The group that were potentially vulnerable customers without adequate information and could lose money.
“This third group were reading social media information and fell into a trap of thinking it was a good investment, even when the stocks were up to $400 USD a share.
“It’s the third group that we wanted to educate and support. We always advise investors, make sure you understand what is underlining your investment decision.
"Based on fundamentals this didn’t look like a good investment decision. So, you need to be clear about what you’re trying to achieve - whether it is long term returns, short term gain or some other personal or social purpose.
“This was one of those ones you don’t invest in unless you’re prepared to lose it all - which is not what most investing is about,” Roberts said.
The Co-Founder of the investment platform says the majority of Sharesies users hold their money in the platform’s funds for long-term growth.
REDnews also spoke to Westpac’s BT Funds Portfolio Manager, Nirav Shah, about the risks of trading on stocks that are trending on social media.
Nirav Shah has a Master of Finance and has worked with Westpac for 15 years, working alongside financial advisors.
He joined BT Funds (Westpac NZ’s investment arm) in 2008 and currently works in investment research and underlying manager monitoring within the investment team.
The game of shorting stocks:
“Wall Street hedge funds have played this game of shorting stocks for years, if they think the company is overvalued,” Shah said.
“This is done by borrowing the stock they think is overvalued from a broker, selling it at market price and buying it back when the price falls, giving the stock back to its owner, while keeping the profit - if their investment thesis is correct.
“However, if the price goes up instead of down, driven by some large scale buying by large or institutional investors, those short sellers will instead quickly see losses as brokers will require the short sales to be repurchased at ever higher prices. This creates a so-called short squeeze.
“Short squeezes are not new, but what is new is those millions of individual investors banding together on internet forums to go up against these short sellers and creating a short squeeze.
“GameStop has become a cautionary tale of the inherent risks of shorting individual stocks.
“The online forum investors acting in concert is a new phenomenon which is causing some concern in the markets and with regulators.
“The sharp and huge price movements in the share price presented a warning that it was risky to get involved. There was a significant risk that inexperienced investors (as well as experienced) would get burnt.
“None of our managers held or were short GameStop shares,” he said.
How this impacted overseas markets and New Zealand:
“Large investors who shorted not just GameStop, but some other stocks too, were forced to reduce their risk exposure and sell some of their more liquid stocks to raise cash to cover their short positions,” Shah said.
“There was a spike in volatility for a while, for example, in the US the S&P 500 fell almost 3% in one day, which was a sizeable decline, before recovering.
“Any volatility overseas does impact New Zealand markets. In the US, there was a lot of controversy around this GameStop issue and regulators are currently reviewing what led to the turbulence,” he said.
New investors and managing risk:
“Many young people are drawn in by stories of making quick fortunes from investing in shares,” Shah said.
“A large number of users of the Robinhood trading platform were young people in their mid-20s and for a lot of them it was their first-time trading.
“They got their information from social media and were exposed to a lot of unqualified statements.
“People confuse trading with investing. The whole point of investing is the management of risk. If you are trading and not managing your risk properly, your gains can turn into a loss in no time and possibly even more losses.
“We’re seeing first-time young investors trading in New Zealand too. It’s a worldwide phenomenon because interest rates are low and house prices are out of reach for many.
“A lot of people feel they don’t have any other option than to go into the markets.
“This is happening everywhere from South Korea to New Zealand, people can’t afford to buy homes, but they have a high enough disposable income to invest.
“I see that trend increasing and it’s really great that people are keen on investing, but it highlights the need to create awareness for long term investment rather than day trading,” he said.
The risks of making your own trades versus investing in a managed fund:
“From a managed fund perspective, our underlying fund managers are well resourced with talented and skilled teams who have expertise and experience in their respective areas,” Shah said.
“They have sound risk management frameworks in place and follow disciplined processes. Their objective is to consistently deliver good risk-adjusted returns and I emphasise here ‘consistency’.
“They understand the companies they invest in and they carefully size up their investment positions to generate returns.
“It is very important to separate investment from trading.
“Day trading on the other hand can experience an intense bout of volatility.
“Just because you hear a few cases of people making a lot of money from it, left behind are numerous people who lose a lot of money, sometimes their entire life savings.
“Sometimes luck can also help traders, but it's not the right way to create wealth over the long-term.
“Investing over the long term enables investors to participate in the long-term success of listed businesses, irrespective of the short-term price volatility, which is inevitable.
“It’s when you have to sell out at lower prices, that you turn an unrealised loss into a realised one.
“I’m not against online investing via apps and for many people it can be an educational experience, but to make money out of it consistently, there needs to be a lot of time and effort involved, especially when that’s not your day job, even assuming you have the knowledge and skills.
“On the other hand, a professionally run managed fund has qualified people working full time on investments with the requisite skills along with clear processes on risk taking and minimizing losses.
“Emotions such as greed and fear drive markets and that’s where professional fund managers can identify investment opportunities which are mis-priced relative to their expectations and make money if their investment theses are realised.
“If you’re only getting your information from media articles and social media, you can be taken by surprise – the key point for any investor is that without proper understanding, your risk of losing money increases,” he said.
How to manage risk:
“Trading is not investing,” Shah said.
“Being aware of risks is the first step to managing risk. Building wealth takes time.
“There is a need for more financial awareness and personal finance education.
“That’s why Westpac offers Managing Your Money workshops, to facilitate financial education sessions.
“Our customers expect us to protect and grow their entrusted wealth and as one of NZ's largest fund managers, we recognise the immense capacity we have to drive positive impact and prosperity for our customers.
“Investing requires skill and speaking to an Authorised Financial Advisor can be of great help, they will do a risk profile analysis to take into account your current situation and your needs.
“You need to be comfortable with what you’re invested in. If you can’t sleep at night, it’s not the right investment for you. Speak to an expert – in the long term this could be less costly,” he said.
Stress and market volatility:
“Financial markets are volatile,” Shah said
“All investors can experience stress to varying degrees, it’s normal human behaviour.
“Over the last two decades, we've seen the dotcom crisis, the global financial crisis and now COVID.
“It's the human tendency to react, but how you manage that behaviour is what matters and how you use risk mitigation techniques to help you live with it,” he said.