To preface, I am not an investor. Not a quant. Not a securities analyst and definitely not an expert on investment. I have a traditional 9-5 day job in tech and like all salaried middle class, I too dream of overnight riches 😊
At best I can be defined as a hobbyist retail investor. My risk taking appetite on stocks at any one time is maximum $300. So, that should tell you about both my expertise and my cojones when it comes to stock expertise!
There is however, one thing that I am good at. Business projections, earnings summary, profit and loss, debt and so on. In short. I read. A lot. About a lot of things.
So, like the rest of the world, when Gamestop (GME) happened, I also watched it unfold with bated breath. The story was movie-esque. A community of retail investors banding together against the suits of Wall Street and winning. Holding long on a short stock, forcing the price to go up and thereby forcing hedge funds to buy more, to cover their short positions.
Ridiculous growth, massive windfall for many investors (retail and otherwise) and financial oblivion for a couple of hedge funds.
I loved the romanticism of it.
The internet is amazing. Coupled with the power of mainstream media it can conjure up information and misinformation in equal amounts in a very short span of time. So when the internet goes crazy about a bunch of middle class office going people becoming millionaires overnight by trading on one stock, the media follows suit.
And what happens then is a zeitgeist. A viral trend.
While GME has been covered to death and there are expert opinions everywhere, I don’t have much to add to it. But what struck me more was another trend.
Yesterday, in both the android and iOS appstores, 7 of the top ten apps were investment apps. Buoyed by the story of the success of the retail investors (GME David vs Golaith story) millions of people were downloading trading apps to become investors overnight.
Take a cursory glance on newsfeeds across Instagram, Twitter and TikTok and you will find social videos of random people explaining their stock positions, stock picks and showing how much profit they made in the last month. None of them are famous investors, but they all have robust followings.
Free market is amazing.
But, are there some risks in the democratisation of the retail investor? Might it be a good idea to exercise some caution in the light of all this overnight investment frenzy?
So let’s unpack this a bit.
While I do not know much about shorts here is the very basic economic principle I do know. Let’s say a company has 100 stocks outstanding at $10 each. If you think they are going up, you can buy 10 of those stocks for $100 outright. Your belief is that the value of the stock in future will be more than the cost of your cash spent now to buy them, thereby earning you a future profit. At the same time, someone who does not believe that the stock is going to go above $10, is selling you 10 stocks for $100 because s/he believes that the price s/he is getting now is the best s/he can get for them.
But here is the thing. You can also bet that the price of the stock is not going to go up. You can then borrow an amount (margin) and sell it to someone with the hope that it goes down in the future. So let’s say you borrow 50 of those 100 outstanding shares and sell them short, then someone is 100 long on those shares, you are 50 short and someone new is 50 long on your short position.
This is where it gets interesting. Even though the company only has 100 shares, two investors now have a positive 150 share balance while you have a negative 50 share balance. So now there is money spent and money created on something that actually doesn't exist. People are making money by selling something they don’t actually own.
And hence the call for banning short buyers and regulating short sellers in the wake of the GME kerfuffle.
This however gets more interesting because the entire global business mechanism runs on people selling things they don’t own or they don’t want to own. A company borrows money they don’t own in an IPO from the public. They then sell this money that they don’t own to other people to buy supplies. They then use these supplies to create a product they don’t want to own and sell it to some other people. The people who buy the product more often than not buy them on credit using money they don’t own.
There is theoretical short selling in every step of how business works and has been for centuries. Every public company is basically shorting “debt”. Changing that entire process is quite difficult. Markets will crash. Economies will disintegrate.
But what saves the market is that for every buyer there is a seller. Does not matter what the product is. And as long as that transaction keeps happening things are kept in balance irrespective of who owns what.
Does not mean legislations are not needed. If a genuinely good company is being hurt by short sellers banding together to make a quick profit that is unfair and needs to be looked into. On the other hand long buyers banding together to jack up the stock price of a company higher than it merits is also wrong. But that’s a lot of boring economics which has no consequence to most of us in our daily lives.
So what matters to us, the common man who has been inspired by this Wall Street saga?
Sure we deserve some profit after all the taxes we pay. But randomly shorting companies is not as easy as it is made to sound on social media and tik tok videos. In the daily course of the life of a company it really does not matter what the stock price is showing on daily trades. It is an index or an indicator at best. Companies don’t pay attention to it every hour. If the company has a flat or even slightly declining revenue trend, no amount of shorting can change their valuation overnight as long as they execute on their plans diligently. The quarterly earnings and S1 filings show the health and future plans of a company clearly.
This can’t be manufactured always by groups of people coming together, like it appears on the GME story.
The people who picked GME to go "LONG", made a very studious bet. First off, the stock was short by more than its valuation which in itself is a red flag. This bet was made on the fact that with gaming going digital, a company making money from trading physical game inventory would disintegrate overnight. But the thing is physical gaming, while on the wane, is still a large part of the market. Even the new XBOX comes with a physical disk drive. Why would MSFT of all companies introduce a physical disk drive if there was no consumer demand for it? Same for Nintendo. The market data did not back the short position. Neither did GME’s quarterly earnings. It wasn’t growing but neither was it in free fall.
Hardcore gamers still swear by their physical gear, and when they want to trade, GME is where they go. Sure digital gaming is on the rise and for brick and mortar gaming stores, the cost of maintaining property is high to sustain a profitable business, but they are not going down tomorrow. Maybe in 5 years. But not tomorrow.
And this was what the GME retail investors bet on. They bet on GMEs survivability horizon of 5 years, to go long. Not on GME’s business model.
So if you want to go short, by all means do. But do some research. Pick up the shorts that look high (those will turn maximum profit), but then research their industry, market, S1 filings, quarterly earnings, news reports, industry trends for a good time. Don’t do it because everyone else is doing it and that by grouping together, there will be success everytime. There won’t. A legitimately good business will not go down overnight, irrespective of how much someone is shorting it as long as it creates intrinsic value for its users (who do not go about their lives watching stock graphs on Bloomberg).
In short, with this new trend of millions of new retail investors downloading apps like Robinhood, SoFi and eToro to then go “short” or “long” on stocks to make easy money overnight, won’t work every time like it did with GME. Some times it may. Other times, people will lose money. Mimicking trades won’t be a win always. The market will balance.
With billions of dollars in government stimuli during the covid pandemic, there is suddenly a ton of money in the system which retail investors in the main street are betting upon. In July 2020, (during the heart of the pandemic) 25% of all global trades were by the retail investor — and that is a pretty huge shift in trends.
The retail investor is here to stay. Their influence will grow. Main street will balance Wall Street more than it has before. Along with that, currency is decentralising. Fintech is booming. SPACS are mushroooming everywhere. All this will create a lot more net new opportunities. But there will also be consolidation. Which means there will be volatility.
So yes. Trading is good. We should all invest, as long as it is with some caution and some knowledge of overall market and business performance.