The GameStop Revolution: What It Means for Traders!

Over the past month a rebellion has manifested itself in GAMESTOP (GME). This event and stock is emblematic of the monetary times in which we live. GameStop represents a host of issues that have been boiling since the 2008 Financial Crisis. Like every good story there is a ton of drama, heroes, villains, criminality and hearsay. But unless you define the backdrop of this canvas very carefully it can get confusing very quickly.

One of the most successful archetypal stories of all time is the tale of an underdog who, in spite of massive odds against them, takes on a much more skilled opponent and vanquishes them.

GameStop is exactly this type of tale.

GameStop is a video game store with over 5,000 outlets where customers can buy, sell, and trade their games, consoles, and gaming accessories. In 2020 they actually lost over 750 million dollars. They had closed 783 stores throughout the country over the previous 24 months. Over the past few years this business model has struggled as gaming has been disrupted by digital delivery platforms that are making GameStop as a shopping center staple almost obsolete. Analysts who study the fundamental business factors of GameStop place a fundamental value on each share at roughly $11.93. Many analysts feel that GameStop is quickly becoming obsolete as customers purchase their video games and equipment online.

Let’s start with the psychology. There is a deep distrust in society for the hedge funds and banks who constantly profit at the expense of the little guy. The mood in the marketplace is that the big guys have gotten bailed out repeatedly for horrible business practices. Whether it was the 2008 housing crisis, or naked short selling the mood on the street is that the larger players are front running trades, have access to lower cost of capital and receive preferred treatment by regulators. This has created a mood where the little guy feels that they are at a huge disadvantage in a system that is rigged against them.

This feeling has been amplified by the Federal Reserve and our elected officials. They continue to intervene in markets via quantitative easing distorted price signals. The dollar is being devalued at an incredible rate, but nobody dares to care about that. This punishes 45% of Americans who live paycheck to paycheck and have no investable assets. They feel they can’t get ahead. Everything is getting more expensive but they’re not making more money.

This is exactly what is happening. The bureaucrats establishing monetary and fiscal policy have built an economic environment that rewards investors, punishes savers. This massive market manipulation of the past year, and specifically the last thirteen years since the 2008 Financial crisis, inflates financial asset prices and devalues savings.

You literally have tens of millions of people who are scarred by the manipulations of the past.

But then the internet accelerates the dissemination of information by democratizing everything. Today you have commission free trading, financial information is readily available to the smallest of traders and it is almost frictionless to buy fractional share purchases at close to zero cost. In other words, you don’t need a seat on the Big Board or a Wall Street connection to play the game.

This mood has been building in the markets for over a decade. In April 2020, Warren Buffett exited all of his airline stocks at huge losses when the economic lockdown was announced. The airline stocks doubled in price within 30 days as small investors, aggressively purchased the airlines almost relishing Buffett’s dismal performance.

But then a truly unexpected thing happened recently. The small trader, through an online Reddit community called WallStreetBets, noticed that the largest hedge funds had shorted 140% of the float on GameStop stock and the regulators were asleep at the wheel. Shorting a stock is when you borrow the asset first in the hopes that it will decline in price, allowing you to buy it back later. How do you short 140% of the float? The brokerage companies just loan out stock that they don’t have to create a return on their balance sheet out of thin air. This practice is illegal and unethical and has contributed to market crashes and prompted regulations against naked short selling.

WallStreetBets theorized that since the regulators, brokerage companies, and hedge funds were colluding, if they organized their 2 million followers and started purchasing GameStop the prices would rise and the short sellers would be forced to cover their shorts at higher prices, creating a short squeeze.

This is exactly what unfolded. An online community of investors and traders who started trading with their stimulus checks last spring banded together and recognized that the hedge funds were massively vulnerable. These individuals had been labeled “dumb money” by Wall Street but now had the upper hand. Within two days GameStop was the most heavily traded stock in the world. WallStreetBets users were posting screenshots of suddenly inflated account balances.

GameStop was trading around $17.90 a share on the first trading day of the year. It traded as high as $486 a share less than 4 weeks later, more than a 26× return in a few weeks. This has nothing to do with fundamentals, technical analysis, or the underlying assets of GameStop. It’s the execution of a short squeeze by the retail trader.

Many of these smaller Reddit traders purchased deep out‑of‑the‑money call options on GameStop. Whenever a market maker creates a call option they hedge by purchasing a small amount of the underlying asset to limit risk exposure, one reason GameStop accelerated so quickly in this rally.

“It’s time for a government bailout of GME shareholders at $10,000 per share. This would be roughly equivalent to the $700 billion bank bailout in 08 that was necessary to prevent ‘systemic risk’.” – WSB user “TheHappyHawaiian”

This tug of war will continue to unfold over the coming weeks. Regulator, politician, investment media, and the trading community have reacted.

CNBC criticized the small trader for recklessly manipulating the market. Melvin Capital, a hedge fund with a massive short position in GameStop, lost 30% of its funds this month. Two other hedge funds, Citadel and Point72, stepped up with $2.75 billion to save Melvin Capital. Ben Bernanke, the former Federal Reserve Chairman, sits on the board for Citadel.

The WallStreetBets platform on Reddit was disabled, justified by users being engaged in hate speech and misinformation. The RobinHood App and trading platform prevented further purchases of the stock. Platforms are using double standards to ban, censor, and ultimately cancel. The Securities and Exchange Commission (SEC) had to step in to say:

“We are aware of and actively monitoring the ongoing market volatility in the options and equities markets and, consistent with our mission to protect investors and maintain fair, orderly, and efficient markets, we are working with our fellow regulators to assess the situation and review the activities of regulated entities, financial intermediaries, and other market participants.”

Truly amazing. Hedge funds positioned themselves 140% short illegally and this is the regulator’s response?

There is nothing wrong with discussing investment ideas and buying a stock with the potential for a short squeeze. Banning or censoring opinions about stocks on the basis of misinformation? Wow!

Traders must disconnect the noise of media from reality. Over the last years, Wall Street and the media have disliked companies like Tesla because they were upsetting the status quo. Traders who follow our AI have told us repeatedly how wrong our analysis was. There were many experts and hedge funds on Wall Street shorting the stock.

Look at the following charts and decide for yourself.

Tesla (TSLA)

Tesla (TSLA)

TESLA (TSLA)

Was our analysis misinformation? Should it be banned because the Wall Street Elite and others disagreed with it?

Just because an opinion is different from prevailing ideas does not mean it should be censored or banned. It also does not mean it is misinformation.

The dangerous thing that has occurred in GameStop is not the volatility or uncertainty. William Gavin, Secretary of the Commonwealth of Massachusetts, calls for a 30‑day trading suspension on GameStop to protect “small and unsophisticated” investors. Many other politicians are doing likewise.

Gavin’s suggestion would have serious consequences for traders everywhere.

First, consider the parameters and definitions required to construct such regulation.

When exactly does a rally become unacceptable or dangerous? 5%? 10%? 2%?

Would strong rallies be considered illegal? Even permissible?

Are we seriously contemplating the idea that price movement is a crime?

In December, GameStop recently appointed three new directors in an attempt to turn the company around. Is this the precursor to market manipulation?

This suspension proposal would put every rally at risk of potential closure––halting growth and cementing their fate into the hands of bureaucrats who deem to know better than the free market.

Rallies are a normal and essential part of financial market activity. At its core, price discovery involves finding where supply and demand meet.

The key difference here is that it was that David pulled one over on Goliath.

Here are a handful of Heavily Shorted Stocks that you should put on your radar to see and understand price action firsthand and how frightened Wall Street is of being on the wrong side of this trend. Over the last week these companies have rallied heavily as Hedge Funds have changed their enormous exposure to naked short selling.

Regardless of your risk profile these are major issues facing every investor and trader today.

So how are you going to navigate the market?