What, if anything, do I do about GameStop when the stock market opens on Monday?

 

That depends on your motivation for buying and selling stocks, your financial circumstances, and your stomach for volatility. Before doing anything, it is important to understand what happened and why.

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The huge increase in the price of GameStop shares was not the result of a change in the current health or future opportunity for the company. It was the result of a trading strategy known as SHORT SELLING, and the success of small investors in creating a SHORT SQUEEZE.

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• Short selling is a technique used by institutional investors when they want to bet against a company. Short-sellers profit from a fall in the price of a company’s stock.

 

• A seller is short because he does not own the stock. The seller borrows the shares in order to sell, believing he will be able to cover the short (buy) at a lower price before the stock must be returned. 

 

• The risk of loss on a short sale is unlimited because the price can theoretically climb to infinity. 

 

• Short interest is the number of shares of a company that have been sold short and not covered. When short interest is high, the price can rise massively and quickly if there is a short squeeze.

 

• A short squeeze occurs when a stock’s price jumps, and short sellers (who bet on a price drop) are forced to buy in order to avoid even greater losses. The scramble to buy only adds to the upward pressure on the stock’s price.

 

• This is what drove the skyrocketing price of GameStop.

 

• A short squeeze can happen in other markets such as Bitcoin when whales (big investors) are caught short on a price rise.

 

The big price swings in shares of GameStop are likely to continue Monday when market opens.

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Many people feel they “missed out” on an opportunity to “get rich” by not buying shares of GameStop before its price skyrocketed and are looking for any drop to buy. Others who bought the stock at $3 or $50 or $100, are looking to lock in their profit and sell.

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What is the right move for you?

That depends on your goal in buying and selling stocks, your financial circumstances, and your appetite for volatility.

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If you invest based on a company’s financial health and prospects, and the fundamentals of GameStop as a company have not changed, buying may not be the best use of your money.

Likewise, if you are not financially or emotionally able to ride a roller-coaster of price swings.

 

If you have money available to invest and you believe the price of GameStop will continue to climb based on more retail investors buying, then you may be able to benefit from a pop in price. If you want to participate but have less of an appetite for risk, after buying you may place an order to sell at a price that locks in a profit or prevents more than a set loss.

 

For example, If GameStop (GME) is bought at $300, and rises to $500, you can sell for $200 profit, or if you believe it will go higher but want to lock in a profit you can enter an order to sell if the price drops to $400, or if you want to prevent a loss, if the price drops back to your original purchase price of $300.

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Please consult with your financial advisor or brokerage firm to determine the types of orders available to you to meet your goals.

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Tip: There is a class action suit against Robinhood trading app which blocked users from buying shares of GameStop, and an investigation by the Securities and Exchange Commission (SEC) to “review actions taken by entities that may disadvantage investors” by inhibiting their ability to buy and sell securities. We will discuss in a future post.

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