Lessons of the Gamestop saga!

Satish Joshi

Technology is liberating, technology is empowering, technology makes the world more egalitarian!

That was the refrain of much of the media frenzy that surrounded a fascinating story which unfolded on Wall Street a couple of weeks ago. From Wall Street Journal, to Economist, to our own Economic Times and Mint – headlines in bold print blazed with the remarkable story of how ordinary, retail investors brought the Wall Street sharks and fat cats to their knees, something that would never have happened in the absence of the technology that empowered these retail investors.

The press was quick to use the RobinHood metaphor – Rob the rich and enrich the poor – and spin a story of a moral victory of the little guys over the big guys. Of course, the fact that the technology that enabled this coup by the small investors was named Robinhood, must have helped this narrative!

But, but, but …. The facts in question should be a matter of concern rather than euphoria!

Firstly, what was the nature of the “coup” itself. Let us look at it step by step.

  1. Gamestop is a loss making, badly run company that was going bankrupt and therefore its stock price had been on a decline for some time. A company, a prudent investor would not normally invest in.
  2. A big hedge fund, Melvin Capital (and many others too) had short sold the shares of Gamestop hoping to drive the price of that stock down even further and making a killing.
  3. A large bunch of retail investors – all members of wallstreetbets group on Reddit – ganged up to purchase Gamestop shares using the Robinhood app in such large numbers that it caused the price to go up at an unprecedented rate, forcing the hedge fund to settle its trades by purchasing the shares at a much higher price than the price at which they had committed to sell and thus incurring a huge, billions of dollars of loss!
  4. In this gamble (and it was a gamble – not an investment strategy) especially given the ease and near zero cost of trading made possible by technology like Robinhood, the amount each individual member risked was little. It is the collective purchasing power unleashed by the group; a collusion made possible again because of technology – social media in this case – that brought the mighty hedge fund to its knees!
  5. However, in this story we were not told facts like these:
    • An 18-year-old student snapped up $928-worth of GameStop shares Monday using his father’s investment account, when the stock was trading around $232, he says. A day later, he has already hit the sell button, almost half of his original investment gone. And this was not an isolated case. He is just one of a horde of traders who loaded up on left-for-dead stocks in the past few weeks, egged on by members of Reddit’s forum.
    • Stocks (where similar campaigns were launched by other “Robinhoods”) Lost $167 Billion while the original group of the Reddit crowd was still preaching defiance! How many hands of the “little guys” were burned in the process, there is no count.
    • And while Melvin Capital may have lost money, other hedge funds, for example Senvest, made $700 Million BECAUSE of the “celebrated coup” by the small investors – so this whole narrative of a moral victory of the downtrodden over the rich oppressors – seems like smoke and mirrors!

So, net net, A worthless stock was driven to irrational valuations by peer group pressure which social media helped amplify, way beyond what would have been possible without the technology. Easy and cheap tools made available by technology like Robinhood seduced many people to follow the herd without considering where the herd was headed and make irrational purchases of impaired assets which in calmer times they would have stayed away from. In the process, a few made big profits and a large number lost their shirts.

The point of all this is – Many of us are enchanted by the rhetoric of “democratization” that has accompanied the rise of cheap online brokerage platforms.  And yes, technology is liberating, and technology is empowering. That makes it trivially easy – and cheap – for ordinary people to invest into the stock market without having to accumulate much insider knowledge or expertise.

BUT as Spiderman’s uncle tells him in the first Spiderman movie – “With great power comes great responsibility“! And I might add to that – With great power comes Great Risk too“.  If you do not know or do not learn about how to wield that power responsibly, all that power and ease of use also makes it easier to make big mistakes.  Secondly, the power of social media fosters and amplifies “herd instinct“, greatly accentuates the fear of “being left out” (FOMO and its cousin FOBLO) and thus starts blurring the boundaries between gambling and investments.

Technology does NOT make investing easy! Technology makes executing transactions easy and cheap. Technology does not “democratize” investing, it “democratizes” transaction execution.  There is a BIG difference between these two.

Moreover, that ease and democratization can create a false sense of confidence resulting in making irrational bets. Technology is no substitute for the hard work that is required in planning your financial goals and rational means of achieving them.

That is why this Gamestop story as told by the mainstream media is so dangerous.