Over the last couple of weeks, the financial headlines have been dominated by market manipulation, GameStop, short squeezes, Reddit frenzies and other uncommon topics. A little perspective makes it easier to understand these events and how they should affect your investment strategy.
The big news was the strong increase in the price of the stock of GameStop, a video game retailer that many investors thought was slowly dying. The price apparently increased because a large number of members in a forum on the Reddit web site said investors should buy the stock.
They said the price would go up at least partly because some large hedge funds had sold the stock short. If the price increased, the hedge funds would have to buy the stock to cover their short sales, and that would make the stock price rise more.
The price of GameStop did indeed rise. After about a week of heavy media attention and a meteoric increase in the stock, the price of GameStop stock tumbled in a couple of days.
The Reddit forum apparently also pushed up the stock price of AMC, a movie theater company, and another forum helped push up the price of silver by recommending it.
Instead of viewing these as new or isolated events, consider them as part of a series of events and changes that occurred over the last few years. The sharp increases in the prices of those investments weren’t the only strange or unusual price actions.
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There was the period when prices of initial public offerings (IPOs) surged, often despite the lack of profits by the companies or even the potential for profits to be generated sometime in the next few years. Some of these companies were called unicorns.
We’ve also seen rapid price increases in shares of special purpose acquisition companies (SPACs). These essentially are investment funds that are formed with vague plans to buy one or a small number of small companies. The SPACs often become publicly-listed and take the smaller companies public simply by acquiring them. In general, the founders and initial investors in SPACs do well while later investors don’t.
Over the last year, the stock indexes and a number of individual stocks continued to rise despite the slowdown in economic activity from the pandemic. These strong rallies were supported primarily by small individual investors who were new to the markets. Often they invested by purchasing options instead of individual stocks or ETFs.
There are several broader trends and events that were behind these odd events and are likely to cause others.
One trend of course is the extraordinary fiscal and monetary stimulus that’s been in place and is likely to continue and perhaps even increase. There’s a lot of additional money in the system, and a big portion of the money is making its way into the markets. Often, the money is in the hands of inexperienced investors who are looking at new ways to invest.
Social media also is a factor. Increased use of social media during the pandemic is making it easier for investors to coordinate their actions and affect market prices in a short time.
Related to this are new investing apps, such as RobinHood, that are easy to use and encourage investors to trade more frequently.
A key factor that makes this new investment activity possible was the move by major brokers in late 2019 to reduce commissions to zero on most trades in stocks, ETFs, and options. The surge in daily average online trades since the elimination of commissions is dramatic, and trading volume continues to rise. The increase in options trading has been particularly significant.
These factors together resulted in the events that generated a lot of headlines and were very profitable for some investors. But the Reddit trading, short squeezes, and other events haven’t had a big influence on the overall market trends. They are a small percentage of the market and of total market trading volume.
We’ll have to continue monitoring markets to see if the social-media-influenced short-term trading becomes significant enough to move the broad market indexes. For now, though, it isn’t. These unusual events shouldn’t affect your overall investment strategy, because they aren’t causing significant changes in the broader investment universe. You might, however, want to allocate a small part of your capital to try to join the short-term profits from these types of events.