If you have not heard about what is happening with Reddit and GameStop stock, you must be living under a rock. It all started in a Reddit forum whose sole intent was to "punish the man.” Thousands of users banded together to run the price of GameStop up. GameStop went from $20 to $460 in a matter of days. Some people have made millions of dollars—others have lost their entire life savings. Should you get in on the frenzy? Listen to this episode of Best in Wealth for my thoughts!
Outline of This Episode
- [1:13] My experience with sports betting
- [3:34] The GameStop stock frenzy
- [5:49] What is shorting a stock?
- [10:15] The impact on short-sellers
- [11:29] The impact on individuals
- [18:35] Is this trend unprecedented?
- [19:37] Why this trend scares me
What is shorting a stock?
Shorting a stock is when you borrow shares from a company (like a mutual fund) that owns shares of the stock you want to short. You promise to give those shares back after a set time and pay the mutual fund interest and fees for borrowing these stocks.
When the hedge fund borrows the shares, they usually turn around and sell them, betting the stock will drop. So if they sell at $20 and make $2 million and the stock price drops to $5, they go out and rebuy the stock for $500,000 to return to the mutual fund. In the process, they make $1.5 million. The hedge fund gets to keep the difference.
Hundreds of thousands of people bought GameStop, driving the price up. One year ago, the stock was selling at $4 a share and in recent days it was trading over $400. It is experiencing wild price swings. But you have to remember: there is no profit until you sell.
How it impacted the short-sellers
As the stock price went up, the hedge funds got squeezed. This happens when they have to cover their losses. Some of the hedge funds had to buy back the shares that they borrowed and give them back to the mutual funds.
If they sold a stock at $20 and now have to buy it back at $300 a share, it costs them $30 million. If they previously sold them for $2 million, they lost $28 million. During this GameStop saga, hedge funds have collectively lost over $3 billion.
How it’s impacting individuals
I read that one kid got $50 for Christmas and turned it into $1,000. But he has not sold the stock yet. Another guy had a few thousand in his account. The next day, it went up to $1 million. He quit his job to do this full-time. But he did not cash out. He is holding on thinking it will go higher. Why are people holding on to stocks that are not worth anything?
These Reddit groups are encouraging risky trades with your whole net worth. They are betting as much as they can at the highest possible risk. It is the very thing that makes my stomach turn over. They seem to be more interested in the game than the outcome. But this is real money. This can be extremely dangerous. One student bet $6,000 and lost it all. So he took all of his student loan money and sold his car—just to lose another $30,000.
True investors focus on long-term investments, diversification, and costs. These Reddit investors do not want to wait 20 years for a payoff. They want to get rich quick. The guy that started the frenzy is reportedly up $14 million. But he left millions in his tracks that will lose big time. A lot of people bought high are going to be in for a rude awakening. This is high stakes gambling.
Why this trend scares me
When I was a kid, a local bookie let me get in on some sports betting. I thought I could easily turn the $200 I had earned into $2,000. Boy was I wrong. I lost it all. Family stewards are not gamblers—we are investors. The stakes are higher. This type of gambling is not any different than betting on football games. Financial stewardship is about limiting risk and being disciplined with a long-term strategy. Are you going to participate? Be careful. Only play with what you can afford to lose—because betting on worthless stocks is just like going to Vegas.
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The Best In Wealth Podcast is hosted by Scott Wellens. Scott Wellens is the principal at Fortress Planning Group. Fortress Planning Group is a registered investment advisory firm regulated by the Securities Act of Wisconsin in accordance and compliance with securities laws and regulations. Fortress Planning Group does not render or offer to render personalized investment or tax advice through the Best In Wealth Podcast. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.