The Rise and Subsequent Fall of GameStop - What Can Investors Learn?

Now that the craziness of the GameStop, Reddit, and Robinhood scandal has settled, I think now is a good time to do a refresher on some lessons learned for those of us investing in the stock market.

So today, I’m going to unpack what happened with GameStop, what you can learn from it, and how you can apply these lessons on your journey to financial independence.

GameStop, Reddit, and r/wallstreetbets

This story began with the Reddit group r/wallstreetbets, a stock market subreddit with more than seven million subscribers. At one point, a discussion thread about GameStop had started in the group, particularly around the idea that GameStop was undervalued. Soon after, major hedge funds decided to short sell GameStop stock.

What’s short-selling you ask? Short-selling occurs when you bet against an overvalued asset with the assumption that its price is going to drop over a specific period. If this happens (if the investor accurately predicts the drop during a specified time period), the investor can see significant returns. This is something typically only done by savvy and experienced professional investors or hedge fund managers.

r/WallStreetBets, however, was a group made up of individual investors. This community of millions decided they were going to stand together and stick it to these hedge funds, and so they began a concentrated effort to drive the prices of GameStop up.

It quickly became a story of the little guy sticking it to big corporations, a modern-day David and Goliath if you will. In just one month, GameStop prices shot from a low of $17.90 per share at the start of January, to an incredible $379 by January 29th.

These are astronomical returns, and almost unheard of on the stock market, hence why the story received so much media attention. But now, almost one month since it’s high of almost $400, GameStop is now settling down - trading for less than $50.

So, what can be learned from what happened with GameStop?

A couple things . . .

1. Market Sentiment Matters

Market sentiment is the general mood and feeling amongst traders and financial markets. Market sentiment can drive the price of a stock up or down in a very short period, exactly as we saw with GameStop.

Market sentiment is important because when you invest in an individual stock, you need to know when your stock is fluctuating, and if those fluctuations are a result of market sentiment or underlying factors within the company. This knowledge should dictate how you respond.

Market sentiment is particularly important in this day and age, largely because social media (such as Reddit, Facebook, Twitter, etc.) can have a heavy influence on how people feel about a stock, thus influencing how they invest. You need to pay attention to how these changes can impact your investments.

2. You Must Understand the Fundamentals

Understanding the fundamentals of any company you invest in is vital. When I say fundamentals, I mean all of the financial information you can find on the company. This can include profitability, revenue, assets, liability, and growth potential. Long-term investors usually always focus on the fundamentals of a company before investing.

GameStop is a good example of a company where the fundamentals were pretty much out the door since they didn’t align at all with the company’s surging market value at the time. With GameStop’s January market frenzy, the company was valued at over 20 billion dollars in market capitalization - despite having closed hundreds of stores in the last few years!

The point being that market frenzies can often push the value of a company’s shares way beyond their fundamentals. It’s essential that you keep a clear head during these periods and do your research, particularly if you are planning to invest long-term.

3. Pick The Right Brokerage Company

All you need to do is look at what happened with Robinhood during the GameStop scandal. With Robinhood, people are able to make commission-free trades. Because of this, Robinhood became the popular “go-to” site to trade GameStop. Unfortunately, Robinhood wasn’t prepared.

After r/WallStreetBets traders zoned in on GameStop, Robinhood responded by suspending trades. Robinhood then capped the number of trades users could make on different stocks - including with GameStop.

Robinhood investors suddenly found that their investing capabilities had been severely limited. This is problematic for many reasons, but in particular, because it puts all of its traders at a disadvantage against traders who are with brokerage firms that didn’t limit their trades.

You don’t want to end up in this situation. This is why you need to thoroughly research the brokerage company you use. Look into the brokerage firm’s customer service track record, fees, reliability, security, history, products and services, and accessibility to investments (to name a few!).

4. Be Careful When You Show Up Late

When people read the headlines about soaring stocks, many are quick to dive straight in, in a bid to make a profit. But the truth is, by the time the media picks up on what’s happening, the rising prices are usually at the end of their run.

GameStop is the perfect example. It soared to almost $400 per share. During the week of its extraordinary price surge, GameStop was all that everyone was talking about - including the media. But shortly thereafter, GameStop’s price plunged back down. This is something we often see in these situations - people chasing after the easiest dollar, based on market frenzy and momentum. And it’s particularly worrying when we know that better money can be made with stable and consistent investment plans.

5. Keep It Boring

On the topic of market frenzy, it can be really easy to get caught up in the hype when you see stories like GameStop. I would recommend that you avoid letting your emotions get involved in situations like this.

Amon and I are happy to sit back and watch the drama play out, and part of the reason for that is we know that we have a reliable investment plan in place. We don’t feel that urge to chase these run-ups and run-downs in the market.

A consistent, long-term investment plan may sound boring in comparison, but that is how we’ve found the best returns with the lowest risk. If you establish a stable investing strategy and remove emotional attachments from these situations, you can keep your head well-above water where others may not.

As crazy as the two months were with GameStop, news stories like the GameStop scandal are great opportunities to learn and refine your investing strategies. Every stock has a story. It’s up to us to learn something useful from them.

Financial Minimalism - A Strategy to Retire Early (FIRE Movement)