GameStop and the Rise of New Generation Investors

GameStop, a struggling brick-and-mortar video game retailer, was undoubtedly the most talked-about company in January. Its share price surged more than 17X, closing the month at $325 a share from $18.84 at the beginning of January. The jump in stock price was not due to a breakthrough in business fundamentals or any buyout speculation. Rather, the jump in stock price was because retail investors bought up the stock and forced a short squeeze, as the stock had been heavily shorted by hedge funds. As a result, some high-profile hedge funds suffered sharp losses totaling billions of dollars.

A short squeeze, the flip side of a bear raid, is a common trading strategy among hedge funds. A short squeeze occurs when a stock moves significantly higher, forcing traders (who had bet that its price would fall) to buy the stock in order to avoid even bigger losses. It is not the first time that hedge funds have been burned by short squeezes. Before GameStop, the most famous one took place in Germany in 2008 during the height of the GFC (Global Financial Crisis). It involved the stock of Volkswagen, the big German car manufacturer, causing some $30 billion in losses to hedge funds. The situation was similar to GameStop in that Volkswagen was struggling, and its stock was heavily shorted by hedge funds. In October 2008, however, Porsche, another major German car manufacturer and a major shareholder of Volkswagen, announced it had increased its stake in Volkswagen significantly. This triggered a huge short squeeze on Volkswagen’s stock, causing the share price to surge nearly 5X in less than a week, and Volkswagen briefly became the most valuable company in the world. The most amazing thing about GameStop’s short squeeze is that although short squeezes in the past were generally a fight between deep-pocketed corporations and hedge funds, or among hedge funds themselves, this time it was between retail investors and hedge funds, and retail investors came out on top. The back story leading up to this epic battle is worth noting.

We should acknowledge that these so called “Robinhood Traders” are not all novice investors, and as a group are becoming a growing influence on market trading and volumes. They were a major force behind Tesla’s meteoric rise, and they also were some of the first investors to jump into the stock market at the height of the pandemic, when many professional investors (including hedge funds) were on the side lines. Although some naive, hapless day traders are among them, many are technology and investment savvy. Many also use complex option trading strategies to execute trades, techniques generally used by more sophisticated institutional traders. 

Technology improvements have made all of this possible. These improvements made fractional-share and zero-commission trading widely available to retail investors, enabling them each to afford a small piece of GameStop but collectively becoming a formidable force. And it is technology that made social media widely available to retail investors, equipping them to learn about investment techniques and share investment knowledge and insights. 

As an industry, we should embrace this new generation of investors, as they are demonstrating how they want to engage with technology as they invest and the growing influence that investing forums have on them. We should learn from their behaviors so we are prepared to address their needs. Many of these new investors are learning about the trade-offs between risk and return and the role diversification plays in a portfolio with a small amount of money. Eventually, as their wealth grows, they are likely to need advisory services, and an understanding of their mindset is critical to attracting this new generation of investors. 

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