The Gamestop bubble is bad for the average investor

I placed my first stock trade in the spring of 2008. The markets, stocks, trading — all of it fascinated me. But like most new investors, it was more trial and error than calculated effort because there is too much to learn in too short of time for a young and impatient person in his early trading days.

By the summer of 2008, I vividly recall having lunch with a classmate who had also just started investing in the stock market. He too was, for the first time, employed in the finance industry and as such worked nearby. That lunch was so distinct because him and I spent the majority of it talking about our new stock holdings, and how everything we owned was in the green. We chuckled, as if titans of finance, about the genius of our purchases and the ease of our gains. “What sports team should be buy?” may as well have been overheard by those sitting next to us.

There are known knowns, unknown knowns, known unknowns, and unknown unknowns. The latter is the scariest premise. Because you don’t know what you don’t know, anything can come out of left field for which you have not planned. While me and my teenage colleague bragged like idiots about our stock picks, more seasoned investors, those who had been through peaks and troughs in the markets and who had seen an overheated market, used us and newbies like us as their indicator that it was probably time to reduce their positions and overweight their cash, because a correction was imminent. That is how it feels today. Reddit threads and the retail investor have squeezed short positions and driven otherwise defunct companies to absurdly high valuations, as other uninformed investors pile on. The world is still in the throes of a pandemic and the stock market is at all time highs.

While retail investors pile into stocks, those with experience in the industry and those in at the companies that are soaring have been cashing out of their positions. Four different directors of Gamestop (GME) have sold stock in their company in the past two weeks, at a minimum gain of more than 800%. Insider sales have to be filed the SEC so anyone can check them out. The SEC is also the body that regulates stocks and exchanges, and there is a good chance that some folks from the WallStreetBets subreddit get investigated for their actions. They would probably start with RC Ventures LLC and its near $20M purchase of GME stock on December 17th, 2020. The SECs rationale will be that pump and dump schemes are illegal. As they probably should be – long term they do more to harm uninformed investors than they do to help them. Do I think WSB should be? No, Big Money was just beaten at its own game. But big money does not like to have egg on their face, and this has been embarrassing for them. Large hedge funds have lost 15% or more. Melvin Capital, a $12.5B hedge fund, will likely go bankrupt. So I expect some strong responses to come from Regulators. Don’t think it’s likely? Just look up the story of Jonathan Lebed. I agree with the sentiment that it is unfair and irrational to prosecute small time investors for doing exactly what hedge funds do, especially when lumped into the broader conversation of lack of jail time and the actions that led to the financial crisis. But there’s a reason the house always wins, and it’s why I expect action to be taken by the regulators.

Perhaps this is all doing exactly what it intended to do. Profit or not, the WallStreetBets army may consider it a victory proving that the people can hold the balance of power, that they can affect the big institutions. That in distributed systems like social media and bitcoin and Robinhood, with equitable access to the markets and finance, they can actually see results from their actions. If so, they can consider it a win.

My trades in 2008 were bets, not investments. I had done little research and they were effectively no better than going to a casino. I thought how could I lose? Everything I bought was going up. This positive feedback loop pulled me further in, until it was too late. I had no stop losses, didn’t even know what they were. I hadn’t hedged my positions, didn’t have enough money to use derivatives to offset losses. I was stuck. I watched my positions fall all the way down, to the bottom in March 2009. Many retail investors like me decided to give up and get out of the market for years thereafter, which is ultimately the exact opposite of what they should be doing. Done right, making a return in the stock market is a slow, long-term process. These bubbles bring people in and burn them, and scare the average investor away.

I imagine that’s how this recent rally ends. When everyone you know is becoming a real estate agent, it’s probably time to sell your house. And when everyone you know is talking stocks, especially if they have never talked about stocks, investing or anything the like in their life but are telling you about the stocks they bought, intend to buy, or recommending to you stocks you should buy, it’s probably time to sell stock and overweight cash. If not, Caveat emptor.