Episode Guide

The episode delves into the GameStop phenomenon, exploring short selling, squeezing, and the market dynamics that led to unprecedented highs in GME stock. With guests sharing their insights, the discussion highlights how a community on Reddit brokered the surge, impacting hedge funds and challenging traditional investment strategies. The conversation emphasizes the importance of understanding market mechanics, investor behavior, and the potential lessons for long-term investors amidst the chaos. Overall, it serves as both an educational piece on market structures and a cautionary tale about the complexities and risks of trading.

Episode Timestamps

Episode Show Notes for ChooseFI: The GameStop Short Squeeze Phenomenon

Episode Summary:

This episode delves into the mechanics behind short selling and the recent GameStop phenomenon. It discusses the coordinated efforts by the WallStreetBets community, which led to an unprecedented short squeeze and price surge for GameStop shares. The episode emphasizes the importance of understanding investing versus gambling, the psychology of market behavior, and the critical nature of financial transparency.

Key Topics Discussed:

Podcast Intro:

You're listening to ChooseFI. The blueprint for financial independence lives here. If you're looking to unlock the secrets to financial independence and early retirement, you're in the right place. Stay tuned and join a community of like-minded people who are getting off the Instagram and taking control of their lives in the pursuit of financial independence. ChooseFI, your home for financial independence online.

Introduction to GameStop and Short Selling

Hosts Jonathan Mendonsa and Brad Barrett introduce the topic of the GameStop phenomenon and the concept of short selling.
The explosion of interest in the stock market from listeners and community members is highlighted.

Understanding Short Selling Mechanics

Guest Brian Forialdi explains the mechanics of what short selling involves, including borrowing shares and the concept of a short squeeze.

What is a Short Squeeze?

A short squeeze occurs when the price of a heavily shorted stock rises, prompting short sellers to buy back shares to cover their positions, potentially driving the price even higher.

The Psychology Behind Market Moves

The discussion shifts towards the collective psychology of retail investors and the role of WallStreetBets in the GameStop saga.
Importance of not confusing investing with gambling is emphasized.

The Role of WallStreetBets

The massive influence of the WallStreetBets community is discussed, highlighting their coordinated buying activities that caused the short squeeze.
Historical context and precedence of coordinated buying in markets are introduced.

Conclusion and Key Takeaways

The conversation concludes with an emphasis on long-term investing strategies and the importance of understanding market behaviors.

Actionable Takeaways:

Consider long-term investing strategies instead of short-term trading.
Educate yourself about market mechanics and stock psychology.
Stay updated on market trends and community discussions around stocks.
Focus on transparent financial products that align with your values.

Key Quotes:

"Investing reflects human behavior with money, transcending mere finance." -
"GameStop is a textbook case of a short squeeze driven by collective psychology." -
"Long-term buy and hold investing shields you from market volatility." -
"Bubbles introduce irrational price swings into the market." -

Morgan Housel's Tweet on GameStop: Link
The Big Short by Michael Lewis: Link

Discussion Questions:

What are your thoughts on the ethical implications of short selling?
How can investors avoid being influenced by market psychology?
What lessons can be learned from the GameStop incident for future investing?
How does the phenomenon of short squeezing impact overall market stability?

Conclusion:

This episode highlights the complexities and psychological aspects of investing in the volatile stock market, particularly through the lens of the GameStop event. It aims to encourage listeners to focus on informed and long-term investment strategies.

Podcast Extro:

You've been listening to ChooseFI Podcast, where we help middle-class America build wealth one life hack at a time.

Understanding Short Selling and the GameStop Phenomenon

The world of investing can often seem intimidating and complex, particularly when discussing concepts such as short selling and phenomena like the GameStop short squeeze. However, by unpacking these topics, you can better grasp how the stock market operates and make informed decisions about your investments.

What is Short Selling?

Short selling involves borrowing shares of a stock to sell them on the market, anticipating that their price will decline. If executed successfully, the short seller can buy the shares back at a lower price, return them to the lender, and pocket the difference. However, it’s critical to recognize that this strategy comes with substantial risks. Since a share's price can theoretically increase indefinitely, the potential losses for short sellers are unlimited.

Action Item: Before engaging in any form of trading, including short selling, thoroughly educate yourself on the mechanics and risks involved.

The Impact of WallStreetBets

The GameStop incident serves as a tangible case study of the power of collective action in investing. Retail investors, particularly those on the subreddit WallStreetBets, noticed that GameStop shares were highly shorted — over 100% of the available shares were sold short. This presented an opportunity.

Key Insight: When retail investors collectively began buying up shares of GameStop, they initiated a short squeeze. This occurs when short sellers start buying shares to cover their positions as the price rises, further driving the price up.

Psychology and Market Behavior

One of the crucial lessons from the GameStop saga is that investing transcends pure finance; it’s also about understanding human psychology. Investors often act based on emotions, which can lead to irrational decision-making.

Quote: “Investing reflects human behavior with money, transcending mere finance.”

Long-Term Investment Strategies

In the wake of the volatility observed with GameStop, it’s essential to emphasize the importance of long-term investment strategies. Individuals who practice a long-term buy-and-hold approach typically weather the storm of market fluctuations better than those who engage in speculative trading.

Recommendation: Focus on investments that are fundamentally sound rather than chasing trends or fads. This not only reduces anxiety during market turbulence but also positions you for stable growth in your portfolio.

Recognizing Bubbles and Irrational Markets

The episode's discussions highlight that every now and then, the market experiences bubbles where irrational price movements occur due to collective behavior rather than company fundamentals. GameStop is representative of this phenomenon, with its stock price soaring without justifiable financial backing.

Action Item: Stay informed about market trends and community discussions around stocks. Understanding the latest market psychology ensures you make decisions backed by data rather than hype.

The Role of Trading Platforms

Platforms such as Robinhood have transformed how everyday investors engage with stocks, making trading more accessible but also introducing complexities and risks. Robinhood's business model relies on selling user trading data, which raises ethical questions regarding how these services operate.

Caution: Consider using platforms that align with your investment philosophy and offer transparency regarding fees and practices.

Learning from GameStop: Takeaways for New Investors

Differentiate Between Investing and Gambling: The GameStop incident underscored the difference between informed investing and speculative gambling. Focus on understanding the fundamentals of the stocks or assets you choose to invest in.
Emphasize Financial Transparency: Always seek transparent financial products that align with your values and financial goals. Being informed can help you avoid pitfalls and make sound investment decisions.
Think Long-Term: Investing based on trends may provide short-term gains, but long-term investing strategies generally yield better financial health.
Join Investment Communities: Surrounding yourself with knowledgeable investors can provide insights and accountability, enabling you to deepen your understanding of investment strategies and market dynamics.

Conclusion: Moving Forward with Knowledge

As we navigate the complexities of the stock market, remember that the principles of investing should center on informed strategies rather than reactive, emotion-driven decisions. Embrace the lessons learned from incidents like GameStop as opportunities to educate yourself and refine your investment approach.

By focusing on a long-term investment strategy grounded in fundamental analysis and understanding the psychological aspects of investing, you can enhance your financial literacy and build a resilient portfolio — one that can withstand market ups and downs without losing sight of your financial independence goals.

Final Thought: “Long-term buy and hold investing shields you from market volatility.” Stay the course and let your investments grow over time.

Wondering what happened with GameStop and confused about what a short squeeze is? The complexity of this kind of trading is far from the simple strategy of buy and hold investing.

Brian Feroldi

What You'll Get Out Of Today's Show

Even for those who have no plans to jump on the GameStop (GME), it's good to understand exactly what is going on. We can learn what's happening, how it works, and move intelligently forward.
In an effort to understand systems, Brad has been having a maddening healthcare experience. He needs a CT scan but hasn't been able to find out what the base cost will be. The negotiated cost won't be known until after the procedure so Brad won't know how much it will cost him until then.
At a macro level, the stock market has had a fairly smooth move up and to the right for the past 10 years or so. For investors, it's been somewhat predictable, at least until this last week when GameStop stock began to skyrocket.
There are aspects of the stock market the average investor doesn't see. Hedge funds are participating with huge amounts of money in layers that are essentially hidden to the masses, until it wasn't, and they got caught unaware.
Brian Feroldi says the last few weeks have been some of the weirdest in the investing world that he's ever seen. The story has infiltrated mainstream culture and he's been getting questions from all over about what is going on. Even his mom sent a text asking about GameStop.
First, GameStop is a physical seller of video games. As video games became popular, GameStop was a great investment, however, once people began downloading video games, its business prospects declined. As a result, GameStop stock prices have also been declining for many years and it is believed they will cease to exist as a business in a couple of years.
Investors or many managers can make money when a stock declines in what's called shorting the stock. A short sale stock is the opposite of becoming a buy and hold investor in a stock.
A short sale works by going to your broker predicting a stock's decline and state you want to short that stock at a particular price. The broker goes and borrows shares of the stock from another investor for the price you stated and you collect the proceeds from the sale. Your goal is to then buy those shares back at a later date for a lower price and return them to the original investor.
The original owner of the stock makes money by receiving a small fee from the person borrowing their stock, almost like being charged an interest rate. The more demand there is to short a stock, the higher the fees.
There is no set timeframe when shorting a stock. I can be shorted indefinitely. However, if the owner of the stock wants to sell it, the broker who borrowed the stock would have to go and find another short for you to borrow from. If they cannot find other shares to short, the transaction would need to be undone on the short side at current market rates.
Most of us take long positions on stocks, believing the stock is going to increase in value. Allowing someone else to borrow your stock in a short position is another way to make money on owning it.
Some brokers like Brian's are interactive and sent him an email asking if he would be interested in allowing his stock to be borrowed or shorted. since he's interested in holding the stocks for a long period of time, he said yes.
Shorting a stock does put downward pressure on the share price. Individual investors don't have much influence, but a hedge fund taking a significant position to short a stock can drive prices down.
The market price of a stock at any given time is simultaneously the lowest price buyers are willing to pay and the highest price sellers are willing to sell at.
Shorts are happening all of the time, so how did GameStop land on the radar of the subreddit group, Wallstreetbets? In the case of GameStop, there were more shares sold short than there were publicly traded, which is something that very rarely happens.
Wallstreetbets took the opposite position, stating that GameStop's fundamentals were different from companies like Blockbuster, and its stock price was actually undervalued.
An article by Andrew Left from Citron Research predicting GameStop stock going down hard caught the attention of Wallstreetbets. Its members rallied together to buy GameStop stock.
It was then that GameStop stock began to rise. Someone with a short position on a stock does not want to see the price rise. Rising GameStop prices kicked off what's called a short squeeze.
There's no logical argument for saying that GameStop stock was worth $4 in December and $400 just three weeks later. What shifted was who was controlling the mechanics of the system.
The members of Wallstreetbets understood that due to the large number of short positions on GameStop, if enough of them got together to buy it, they could force those in short positions to buy back into it.
GameStop was priced for bankruptcy. While there's no limit to how high a stock can go, the lowest it can go is $0. In that case, the short seller earns a 100% return on their money. However, when a stock rises, being short on a stock can cost significantly more than you put into the stock.
To get out of a short means you have to buy the stock. The buying demand placed on the stock increases the share price. When all of the short sellers saw GameStop's stock price rise, they had to try and get out by undoing the trade by buying the stock themselves, putting more upward pressure on the stock price and on other short-sellers who wanted to undo the trade. That's why GameStop stock prices rose so dramatically in such a short period of time.
Short squeezes are not a new phenomenon. In the past, other heavily shorted companies have come out with good news and saw their stock prices skyrocket. What makes the GameStop situation unique is that it resulted from a coordinated group of buyers banded together to make it happen.
In this short squeeze, there was additional controversy surrounding Robinhood, the zero-commission broker. Because Robinhood doesn't make money on trades, they make money by selling your trading information to high-frequency traders who can make money with micro-transactions. It's those traders who are the real customers of Robinhood.
When GameStop and other heavily shorted stock prices began to rise, Robinhood's hedge fund customers began to lose a lot of money so Robinhood decided to stop trading with these stocks to give the hedge funds time to undo their trades. Meanwhile, Robinhood's small investors were not allowed to buy and sell.
Robinhood aggregates and sells client trade information to the high-frequency traders who can buy the stocks then turn around and sell it to the Robinhood client seconds later for a little extra money.
Robinhood's business model probably works out for a buy and hold investor at the micro-level, but the GameStop situation highlights what can go wrong when each other's incentives are not aligned.
What this demonstrates is that the game is stacked against an individual investor trying to enter and exit the markets with precision. But for the buy and hold investor, this has been mostly noise.
To summarize what happened this week, Brian quoted Morgan Housel who recently tweeted, "The GameStop thing is a reminder that investing is not the study of finance. It's the study of how people behave with money. And sometimes those behaviors are incredible."
Brian says there has been a huge rise in demand for Environmental, Social, and Government (ESG) funds. The exact definition of what ESG investing means varies from person to person so read through the fund to ensure it meets your definition. There are a lot of ESG funds to choose from now and fees have gone down, especially since Vanguard now has an ESG fund.
If you listened to Monday's episode on M1 Finance, M1 does not sell mutual funds, they sell ETFs. The ETF version of VTSAX is VTI.

GameStop: Squeezed to the Max | Brian Feroldi
Episode 293

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Brian Feroldi
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I teach investors how to analyze businesses so they can invest with confidence.

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