颁谤别诲颈迟:听 via
- Irene the Investor thinks that the value of Company X鈥檚 stock is going to plummet.
- She borrows 100 shares of Company X鈥檚 stock from her broker, then sells them at their current value, or $50 per share.
- After a certain period of time, Irene has to return her shares to her broker. But now, she can buy the stock back at its current value, or $20 per share.
- She makes $30 per share in profit from Company X鈥檚 bad fortunes.
So what's the risk?
If, instead of falling, Company X鈥檚 stock climbs to $100 per share, Irene is on the hook for that $50 per share difference. Her broker won鈥檛 let her keep that stock indefinitely, especially if she doesn鈥檛 have the funds to cover her losses. Eventually, she鈥檒l run out of time and will have to give her borrowed shares back at a massive loss鈥攚hat investors call a 鈥渟hort squeeze.鈥�
Tony Cookson, an associate professor in the Leeds School of Business, likes to reference a famous quote by the economist John Maynard Keynes: 鈥淭he markets can remain irrational longer than you can remain solvent.鈥�
The quote seems particularly relevant to the story of GameStop, a video game retailer that many analysts thought was destined to share the fate of Blockbuster.
Then in January, a group of everyday investors, many recruited through the online platform Reddit, seemed to have pulled off the ultimate 鈥渟hort squeeze鈥濃�攖emporarily catapulting the value of GameStop鈥檚 stock and causing major headaches for Wall Street hedge funds.
Cookson studies the behavior of investors. In 2020, for example, he and his colleagues base their decisions on the feedback they get from internet 鈥渆cho chambers鈥濃�攍osing money as a result. The saga of GameStop, he said, shows just how much the online world has fundamentally changed how the stock market works.听
He sat down with CU Boulder Today to talk GameStop and why it may not be the David and Goliath story that many internet memes suggest.
From an investor behavior standpoint, what makes the GameStop situation so unusual?
One of the things that I teach in my investments classes is that if you鈥檙e an individual investor, once the information about a stock reaches you, don鈥檛 bother making bets on individual stocks. Even if you have read a news story about the company, you don鈥檛 have any information that the market doesn鈥檛 already have, and information is what typically moves prices.
In this case, the institutions, the sophisticated investors, had听information that GameStop was priced too high, so some of them took short positions in the stock. Yet in the face of that, retail investors seem to have piled in, driving up the price, and made it so expensive that those sophisticated investors had to close out at huge losses.
This story has really struck a chord with people in a way that many news stories about the stock market don鈥檛. Why?
The message we鈥檝e seen in the media is that this is a case of the little guys versus Wall Street, which captures the imagination of people beyond finance. I don鈥檛 think it is that simple.听
How so?
Tony Cookson
Some funds have had to close out in a losing position, but there are plenty of institutions, also sophisticated money, who piled in with these retail investors and went along for the ride. Given the information these institutions have, it鈥檚 pretty unlikely that institutions would see this situation and not act on it.听
So it may be more of a case of Wall Street versus Wall Street?
Indeed. Based on the numbers I鈥檝e seen, from , retail investors were net sellers of GameStop on Tuesday, Wednesday and Thursday last week. GameStop reached its high of $483 per share on Thursday. After the initial jolt of interest by retail investors on Monday, it looks like GameStop reached new highs due to mostly institutional trades.
You鈥檝e studied how investors are changing their behaviors, and losing money in many cases, based on internet 鈥渆cho chambers.鈥� Do you see connections to what鈥檚 happening with GameStop?
Yes. We study how people confirm their investment opinions by following other users with similar opinions on an investor social network called StockTwits. In our setting, we can see, for example, that some of these people are bullish on GameStop stock, and they鈥檙e not really seeing any information that goes against that opinion. Because they follow people like themselves, they鈥檙e going to hear information, spins on news about GameStop that are going to be more positive on average.听
We study all sorts of stocks, not just GameStop, and we find in our paper that this sort of echo chamber associates pretty strongly with trading volume in the market, and we also find that this is costly for retail investors. Following the recommendations of people in your echo chamber is often a really good way to lose money.
The brokerage firm Robinhood has received a lot of criticism for restricting GameStop trading? Why are people are so upset with them?
I think people had the impression that Robinhood was protecting the institutions that were on the opposite side of this. However, as a brokerage, they have certain requirements they have to meet. It鈥檚 the nature of what they do that they can鈥檛 let all their investors pile into this one position because it exposes them to risks that regulators wouldn鈥檛 allow, without Robinhood posting significant sums of money as collateral.
How, if at all, might this affect the big traders moving forward?
This situation is driven home just how risky doing a short sale can be. These funds may be a little more cautious about taking a short position moving forward, especially with stock that is already heavily shorted.
What would you tell normal investors about how they should approach the current, volatile market?
If you鈥檙e a normal investor, you shouldn鈥檛 be dealing in daily trades. Day trading, or riding these bubbles, is gambling on other people鈥檚 emotions.
My recommendation for the normal, everyday investor is to stay diversified. Diversification keeps you from being exposed to the weird risks that can happen because of investors鈥� random ideas. You don鈥檛 want to subject yourself to those risks, especially if it鈥檚 your retirement savings
