What the heck happened last week to a few securities, seemingly skyrocketing in a few hours trading and creating headlines on ALL the networks. Not just business, or political networks, but all of them.
Wallstreetbets is a discussion board on the Reddit platform. A quick look at the FAQs gives you an overview of what it’s all about.
This group, which at first glance, you wouldn’t give much of a thought to, have seemingly stuck it to a few hedge funds. There is a lot of discussion and thought around the reasoning behind the group, however you can safely assume that at some point they or their families were victims of a Wall Street that created excessive risk, was ultimately bailed out and left the little guy behind.
There are thousands and thousands of discussions on this platform, and some I’m surprised to say are as good as any analyst report I’ve read. It’s definitely more than just a bunch of tech kids writing code. There is some deep analysis there. Unfortunately, from what I see, the motivation is revenge rather than long term capital asset appreciation, and when motivations get misaligned, that has the potential for problems.
It’s hard not to root for these guys, David vs. Goliath, and they are doing it in the most transparent of ways. But I doubt that the hedge funds they are going after will be the only ones that get hurt in this scenario. Most retail investors are still emotional investors and tend to get in late and stay in later, and this type of exuberance generally ends badly.
For some unknown reason I’m not allowed by compliance to mention an individual equity position in these notes, however I’m sure you’ve all seen the explosion in the shares of a video game retailer last week. This push through the discussion boards on Reddit drove the stock up around 1,600% in a couple of weeks. The idea was to squeeze Melvin Capital who reportedly held a large short position in the video retailer. A short position is when you borrow shares from a brokerage house, sell the stock first and buy it back later. Short sellers are hoping that the stock will go down and when they buy it back, they make a profit.
One of the major risks in short selling is your loss could be infinite. Let’s just think about how we normally invest. We could buy a stock for $1. Our maximum loss is $1 if the stock goes to zero, however our upside is infinite, as the stock could go up to any price. The exact opposite is what short sellers deal with. So, when a stock runs up, like we have just seen, the short has to cover (or buy back the stock) to stop the bleeding. With trading today being so quick, these losses can stack up in the blink of an eye.
There is currently a debate around whether Melvin Capital was bankrupt after the move, however I think it would be safe to say that when their clients get their statements this month, they’re probably not going to be happy. The classic part about this whole situation is that from a fundamental standpoint, the short position probably makes sense. Brick and mortar video stores don’t seem to have an appeal, when you can download a game in seconds. Ask Blockbuster how that turned out.
So back to reality, our world of investing is a lot different. First, we are long term, long only investors, basing our decisions on fundamentals. We diversify through a number of individual securities, where no one position generally gets above a 4% weighting. If we get a run in a stock like we have seen, and it pushes the weighting above the 4% that I’m comfortable with, then regardless of my thought on the stock, I’ll trim it back to its original weighting. This isn’t rocket science, it’s just how we manage risk. Sometimes you sell out and the stock continues to rise. Rather than think I missed out; I say that’s ok we still have our original position in it.
Anyway, I wanted to give you a quick overview of what transpired last week, and both let you know where I stand and what if any impact it could have. If you have any further questions, please feel free to reach out.
Here’s the buy/sell.
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