Because we have been getting a lot of inquiries about Gamestop (GME), AMC Entertainment Holdings (AMC), Express (EXPR), and other such companies, we wanted to share some of our thoughts on the risks involved with trading these names now.
We believe that the volatility and risk associated with these stocks are just too great to take any type of position (long or short).
- The market is a sophisticated "barter" system. It matches buyers and sellers in real-time. Like any other market, when demand outstrips supply, the price goes up. When supply outstrips demand, the prices goes down. The bloggers on Reddit seem to have created enough demand to create a significant surge for GME's stock, which is what has driven the price up.
- When a stock experiences unusually high volume and volatility it is classified as a "Fast Market," and brokers (i.e. Schwab, Fidelity, Morgan Stanley, Robinhood...) are not held to the same constraints as they are during a regular market. Price quotes for securities in a fast market can be inaccurate, possibly leading buyers and sellers who are not experienced to execute trades at prices other than what they expected. Markets have "Circuit Breakers" designed to stop the trading of securities in fast markets, allowing those trading to take more time to consider their actions.
- Trading systems can become overwhelmed, causing brokers (including Schwab) to have failed execution of some trades.
- Extreme headline risk: Brokers are subject to SEC and FINRA regulations. Brokers (like Robinhood) may take action (like halting all trading in the securities) while they determine if they are required to prohibit or allow the trading to continue. This led to a 44% drop in GME's stock price on 1/28/2021.
- Short positions are exceptionally risky: Unlike when you buy a stock, where the most you can lose is what you invested in a stock, there is not limit to what you can lose in a short position. As an example, if you bought GME on 1/4/2021 at $17.25 (its closing price), the most you could lose is $17.25. However, if you sold the stock short at $17.25 and had to deliver it at today's price, you would have lost $308.86, and the higher the price ultimately goes, the more you would lose. Melvin Capital (a hedge fund), who was short GME, needed to take a $2.75 billion (35% of the fund's starting value this year) infusion from Citadel and Point72 to close out its short position in GME.
- Reddit blogs may be deemed as stock manipulation by regulators, and there is a possibility they will be shut down.
- Social media allows many people to come together quickly, and if they desire, manipulate the price of a stock. As some of you may remember, not long ago Elon Musk (founder of Tesla) was very vocal about those who put short pressure on his company (TSLA). He used his influence to support the flurry of interest in getting long GME, very likely helping drive the price higher, causing more pain to those who chose to short the company. The question we must ask is does he believe in TSLA, or does he believe in getting even with those who short sell companies in the market? We may never know.
- At the end of GME's impressive run, there may be as many sellers as there are buyers now, and it may drive the price down in the same way current demand has driven the price up.
- One of the fundamental investment principals that we believe it is DO NOT PUT YOUR LONG-TERM GOALS RISK FOR SHORT-TERM SPECULATION.
Our firm believes that the risks around these stocks are just too great, and we advise not getting involved.