What a crazy last month. Jeff Bezos is stepping down from one of the country’s largest companies and there was a significant story regarding short sellers in a certain video game retailer. Due to industry regulations, I cannot disclose the specific company name. Hopefully, you know who I am referring to. I am fascinated by this story and wanted to further discuss what happened and what it all means and the outcomes.
To understand the full story, we need a bit of background. This video game chain store had been hit hard in the last few years and the coronavirus pandemic certainly did not help. This environment would normally interest short sellers along with potentially normal investors. What is a short seller? A short seller is betting that a stock is going to go down. When most of us think about buying a stock, we do so with the hopes that it goes up. When the stock goes up, we make money. A short seller makes money when the stock goes down. Short sellers do play a significant and important role within the Wall Street ecosystem. The profit motive of making money when a stock goes down historically has helped uncover fraudulent companies. Short sellers are good at uncovering bad balance sheets or bad bets by companies.
Why do we mention short sellers? Short sellers play an important character in this story. The other important characters in this story are the hedge funds. A hedge fund can be thought of as exceptionally large investors. If you invest money in the market, you can think of yourself as a “hedge fund.” Investopedia defines a hedge fund as “alternative investments using pooled funds that employ different strategies to earn active returns.” This is opposite to an individual investor. An individual investor is you and I investing our money in ways that we think are going to make money. We have seen the individual market proliferate dramatically in the last several years, and in particular since COVID-19, with the growth of commission-free trading platforms where investors can easily buy and sell stocks. These forces came together in a unique way to create the story.
The hedge fund took a large short position on this video game retailer and it was discovered by some individual investors. The individual investors used a social media platform called Reddit to notify other individual investors of this hedge fund’s short position. As a result, many other individual investors took a long position, preventing the hedge fund from gaining on their large investment. All hell broke loose thereafter. The shares had risen over 3,000 percent in just a few weeks, according to Forbes.
Most Americans who follow the market even passively understand this part of the story. Most Americans believe that it was the “little guy” who won in this frenzy. The truth is, like the old adage goes, the rich get richer. The four largest asset managers own almost 40 percent of this company’s shares according to regulatory filings. Having the stock increase 3,000 percent would obviously generate returns even with the short sale investment. According to the Washington Post, these funds gained roughly $1 billion in value since the beginning of 2021! When you have hundreds of millions of shares trading at almost $300 per share, the little guy has a hard time competing or paying for that.
Technology has changed in a way that not only allows individuals to trade, but it also makes things easier for Wall Street. There have been programs developed to monitor sites like Reddit to find what stocks people are looking into and capitalize off of that information. It has become much harder for the “little guy” to get ahead of the hedge funds when they have already bought and sold a share before the rest of us can get in. The individual investors and Wall Street are more alike than we think; they’re all trying to make money.
The average stock is held for four seconds. Four seconds!
This illustrates that an overwhelming number of trades are bought and immediately sold. They are not being purchased to be held for long term, rather they are being purchased in order to resell to an individual investor at a larger price or they are being sold to capitalize on profit, which is what was happening in this case. The ultimate winner here in the big picture is the small investor as it has caused people to start thinking more about the market and where they should put their money. Current market conditions have also contributed to this. The S&P 500 was up 16 percent in 2020. That large of an increase is bound to attract new investors. New investors need to be careful about how they proceed; if this case illustrates anything, it illustrates that Wall Street knows how to make money.
These platforms have introduced millions of new investors to Wall Street and many of those investors will lose. This is particularly true if they are investing just to make money. Warren Buffett always talked about using the market as a tool to achieve your objectives. My recommendation is to do just that. Use the market as a tool to achieve your long-term retirement goals and avoid any “get rich quick” opportunities that seem too good to be true or are too risky. In my experience, they usually are.
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