Lessons to learn from the GameStop episode

In early 2021 US video game retailer GameStop found itself at the centre of a speculative frenzy between major professional investors and small-scale individual investors.

Hyped by tips on web-based message boards, individual investors bought huge volumes of shares in a perceived ‘David v Goliath’ battle with professionals who expected the share price to fall.

With massive volumes of shares changing hands daily driven by rumours, the share price gyrated wildly for months, leaving some investors, large and small, severely out of pocket.

The beginning – Game(Stop) on

Founded in Texas as Babbage’s way back in 1984, video game retailer GameStop built its business on sales of consoles and game CDs/DVDs. Helped by the expansion of its own store network and the takeover of rival chains like EB Games and Micromania, in 2019 GameStop operated over 6,000 video game shops across the world.

However, in recent years GameStop’s shops faced increasing digital competition, both from online gaming console sellers and the growing popularity of games downloads from services like PlayStation Network, Xbox Live and Nintendo eShop.

After peaking at nearly $58 in late 2013, by the end of 2017 GameStop shares fell to around $18, reflecting some investors’ concerns over how the company could adapt in the face of this new competition. For some commentators, the situation evoked memories of video rental chain Blockbuster, which collapsed in 2010 after streaming services like Netflix and Amazon Prime Video won over customers.

The middle – Game(Stop) over?

With faster internet connections making downloads ever quicker and more convenient, some larger professional investors took the view that GameStop’s woes could deepen. Some hedge funds – a kind of professional investment group that pools capital and can make high-conviction investments in financial markets, often for institutional clients – believed that the share price could have even further to fall.

So they began to ‘short sell’ GameStop – temporarily borrowing shares from other investors that they then sold, aiming to profit from further share price falls that would enable them to buy back the shares at lower prices, then return them to the lender.

Initially, things seemed to go well for the hedge fund shorts. After GameStop announced a record annual net loss of $673m in early 2019, the share price slumped to below $4.

But the tables began to turn in 2020, despite mixed results from GameStop management’s restructure of the business. Encouraged by posts on social media, including the WallStreetBets Reddit forum, GameStop shares increasingly caught the attention of internet-based private investors, many gamers themselves.

The end – GameStop or GameShock?

A surge of buying from waves of these new investors, many on app-based trading platforms and encouraged by forum posters – some of whom had potentially already bought stock for themselves at lower levels – lifted the shares to around $20 by the end of 2020.

Hedge fund short sellers came under pressure as the price rose, with many having no choice but to urgently buy back the shares at a higher price than they had sold them at.

The share price surge attracted widespread coverage on TV and newspapers, as well as frenzied activity on web forums. With hedge fund short sellers squeezed out and even more private buyers piling in, the shares surged to an incredible $450 in January 2021. In a phenomenally volatile market, shares in the retailer were changing hands for 100 times their price of only a year earlier.

So, David beats Goliath, again. What’s not to like?

UK-based investors opened over 1 million new trading app accounts during the first 4 months of 2021, half of these in January alone as private investors scrambled to jump into much-hyped so-called ‘meme’ stocks. Alongside several others, GameStop saw a big surge in trading activity.
 

And like some rollercoasters, GameStop shares were a wild ride that left many wishing they’d sat this one out and just watched on from the sidelines.

Attracted by the dream of quick and easy profits, some retail investors, driven by tips from friends and speculation on web forums, got burned after piling in and buying at the very top, some probably using borrowed money.

On 29 January 2021, the FCA released a statement reminding investors of the risks of buying shares in a volatile market while the Securities and Exchange Commission, the leading US financial regulator, also released a statement promising to review recent trading volatility and ‘protect retail investors when the facts demonstrate abusive or manipulative trading activity’. Having peaked at $483 by the end of the month, GameStop shares gyrated wildly in early February, before plunging to $42 barely 3 weeks after their peak.

Yet GameStop’s business outlook wasn’t changing much – the extraordinary volatility was due almost completely to frenetic short-term speculation about where the share price could be heading. Although some of the hype cooled, the shares stayed fairly volatile, surging from $150 to nearly $350, then all the way back down again, in the 4 months to early August. Subsequently, volatility eased a little, with GameStop shares largely holding in a $160 to $220 range, broadly following the swings of the wider US stock market into mid-November.

Hype's winners and losers

The GameStop saga is a classic example of speculative investment driven by hype and FOMO (Fear Of Missing Out) – in this case of quick and easy profits. Although some investors undoubtedly made fast money from the GameStop frenzy, many taking pleasure from the ‘little guys socking it to the pros’ and ‘torching the big guys’, others tell a different story.

Lots of inexperienced investors, many of them probably owning shares for the first time, got in at the wrong time, suffering quick and painful losses – a costly experience that will stay with them for a long time.

Of course, some of these relatively new investors would have realised the risks they were exposing their money to, and wanted to exercise their right to make their own decisions with their own money. But others had less understanding of the risk that things could go wrong for them quickly if the market turned against them.

One important lesson from the 2021 GameStop rollercoaster is surely this – if you are drawn to an investment because of the hype around promised high returns then ask yourself what the drawbacks might be.
 

As with any investment, it’s essential to understand the risks involved, as well as the potential opportunities. Also, it’s important to consider all the costs of investing; short-term investments can cost you a lot in buy/sell spreads – sometimes called ‘bid/offer’ spreads – that aren’t always very visible, sometimes with transaction fees on top.

Meanwhile, investors dealing in overseas shares should also consider the effects of currency moves and even extra charges made by trading apps on international share transactions. And, as many who used loans including credit cards and tech-based ‘Pay’ services to speculate on GameStop will testify, it can be very costly to use any kind of leverage to invest, especially on speculative investments driven by hype.

Collectively, all these ‘real world’ trading costs can soon add up, eroding any profits you make on winners and also adding to the money you drop on losing trades.

The GameStop share price gyrations of early 2021 remind us that buying shares in a volatile market is risky, and anyone doing so may quickly lose money. And, while the FCA wants to help consumers access investments – including stock market-based ones – that suit their circumstances, there are parallels between the drivers which led to some buying into the meme stock trading hype and those who speculate on volatile, high-risk investments such cryptos and Contracts for Difference (CFDs).

It’s important to remember that these and other speculative strategies are only appropriate for experienced investors who fully understand – and are willing to run – all the risks involved in the pursuit of higher potential returns. These risks include the real prospect of losing some or all of the money involved.

Smart investors diversify to spread their risks

Rather than relying on any single investment to go well, it makes sense to spread your overall risks by diversifying your investments across different assets that don’t all move up or down in tandem with each other.

Learn how diversification can reduce your investment risks and help smooth out the overall performance of your investments over time.