Speculative Trading in GameStop Is Instructive for New Investors

Recent trading activity in GameStop and other heavily shorted companies has generated significant conversation around the morality of retail investors' actions to coordinate purchases of companies through online forums. Some see the events as a vindication for the “little trader” who was trampled during the great recession while big hedge funds were able to recover quickly. Others see it as irresponsible gambling that exposes investors to undue risk.

No matter where your opinion falls on the spectrum, this event has left its mark on our financial system by introducing new investors to the roller coaster of investing and trading. Every decade or so, investors are exposed to various “shock events” that shape our financial markets through new regulations or behaviors while teaching an upcoming generation many timeless lessons. With an estimated 60% of recent GameStop purchases being conducted by first-time investors, there is a tremendously positive opportunity for a new generation to learn from what they have experienced.

Same lesson, different day

From a technical standpoint, what unfolded with GameStop is called a “short squeeze” and is not particularly unusual. Notable other short squeezes date back to the famous Piggly Wiggly short squeeze of 1923 and, more recently, Volkswagen’s stock exhibited like behavior in 2008. Every one of the events had a catalyst. In the instance of GameStop, investors have now been exposed to the world of viral social media investing, which prompted the price volatility. Although unique in approach, this new form of social investing has taught GameStop investors timeless lessons that previous generations have learned as well.

The biggest lesson in these events is that when a stock becomes materially detached from its fundamental valuation, it is only a matter of time before the price returns to reasonable levels. A coordinated entry is generally easy to organize, but coordinated exits are all but impossible to orchestrate. This leaves thousands of investors at risk of significant loss as the peak price collapses without notice. Akin to running with the bulls, someone at the very back will get trampled. From an investing perspective, where the aim is to grow wealth over time, this type of investing makes little sense.

Turn lemons into lemonade 

There is light at the end of the tunnel, though. These new investors have now been exposed to the trials and tribulations of investing. Stories of big gains and losses pepper the internet, but for all this frenzy and attention on GameStop, new investors can take this opportunity to understand that patience, time and emotion management are the most powerful tool any investor has in their arsenal.

With so many investment combinations — nearly limitless — it is all but impossible to select the next hot ticket with perfect timing. Instead of following a social media crowd chasing the next short squeeze, new GameStop investors should heed the advice being offered to them by experienced investors that investing is not a “get rich quick” strategy. Time is our friend in the investing world, as it smooths out bumps along the way and, when coupled with fundamentally strong stocks and the power of compounding, has shown to be an excellent wealth builder.

Capital market strength

For all that we have recently witnessed in our capital markets, it is encouraging to see that they have largely functioned as designed and remain a cornerstone of the largest and most successful economy in the world. New investors have taught institutions lessons, and vice versa. Regulatory bodies will likely review and intervene where necessary. This is an opportunity to reflect on the impact it may have had on your net worth.

Building investments incrementally instead of chasing quick profits will help guide you to your long-term goals. It takes years for professional athletes to reach peak performance, just like it takes time for individuals to develop discipline and grow wealth, but in the end, wealth is built through continuous small acts that over time can grow into something substantial. This is the CapWealth way, and has served our clients well for decades.

Grant E. Stark, CFA, is director of research at CapWealth Group. He co-manages CapWealth’s investment strategies and develops the firm’s investment policies.