After the Reddit group Wall Street Bets told followers to go long on GameStop (GME), the stock has been rising in a momentum bubble, gaining a massive 1,000% since last year. The shares have gained 245% so far this year and are up a further 28% in U.S. premarket trading Monday. But it is sure to crash imminently.
GameStop was the most watched stock in the US on Friday as profits for longs and options were the hot topic across all platforms. What is so unbelievable is the growth the stock has seen over the past few days, gaining 51.08% on Friday alone. GameStop shares were even halted twice on Friday due to the extreme price action.
One redditor posted on Wall Street Bets they invested $565 last year which has grown into a phenomenal $117,110.
So why did GameStop rocket?
The company is a dying retailer selling gaming computers and equipment and saw this boost purely from the hype of social media players on the platform Reddit. The price of the stock is highly detached from reality, meaning this bubble has to pop sometime soon! The stock trades higher now than the peak of the business back in the 2000s. The downfall of GME happened when you could start downloading games straight to your device in 2007, making retail stores selling the physical games redundant. In the world of brick-and-mortar retail, if you don’t adapt, you don’t survive.
Starting from December, investors were betting the stock would go up and fast. This sparked a feedback loop. This process of delta hedging describes mass buying call options equalling the force of market makers, yet market makers such as the New York Stock Exchange didn’t act on this.
GameStop added three new board members from RC Ventures on January 11th – Alan Attal, Ryan Cohen and Jim Grube. These transfers will provide the expertise in e-commerce, online marketing, finance and strategic planning needed to revive the gaming and entertainment company.
Mr. Cohen said, “We are excited to bring our customer-obsessed mindset and technology experience to GameStop and its strategic assets. We believe the Company can enhance stockholder value by expanding the ways in which it delights customers and by becoming the ultimate destination for gamers. Alan, Jim and I are committed to working alongside our fellow directors and the management team to continue to transform GameStop. In addition, we intend to bring additional ownership perspectives to the boardroom.”
Ever increasing share prices force short sellers out of their positions making them buyers in the “short squeeze”. This pushes share prices even higher, encouraging retail investors to buy in. This makes the stock price inflate so high it is almost laughable . This cycle continues as long as those who have gone short continue to be forced out of their position and those who have gone long still hold hope that stock prices will rise higher.
While Citron Research’s $20 price target for GameStop could be correct for the long-term, the price rise from retail investors pushing GME have seen the share price rise to $60 in the short term. There simply aren’t enough shares to sell short.
There is one hedge fund that has hit the jackpot by going against the bearish consensus back in April 2020. The South Korean hedge fund, Must Asset Management, bought 4.6% stake in GameStop. The chief executive officer commented this morning “We have become less bullish and turned more neutral on GameStop. This stock will continue to be very volatile and unpredictable in the short term.”
Financial institutions were right but have majorly lost out by selling short. The hedge fund Melvin Capital Management suffered, overall being down 15% this year because of its GameStop short position.
Is it too late to go long now?
The short answer is yes, it is too late. Looking at the fundamentals, this stock is definitely going to crash, and soon. We are unlikely to see a turnaround unless the company uses its newfound growth to invest in the business. A rumour on Reddit says GameStop could become the new centre for customizable gaming computers – making use of the remaining stores for consultations and gaming. This may just be a pie in the sky idea, whereas in reality online competitors such as OriginPC.com and DigitalStorm.com make a physical store a pretty unattractive option. After all, how many gamers would rather go to a store than order online?
We can be reassured that GameStops success is not here to last as their market cap no way matches the height the stock price has reached. In this case the retailer was smart to buy back shares as the value has increased tenfold. It also now gives them the ability to sell their shares publicly at a much higher price.
What will stop GameStop rising higher?
As the price rise isn’t attached to the true value or performance of the company, the short squeeze will continue to push prices higher. Once this positive feedback loop is broken, the stock will crash. While GME stock could continue to run over $65, this will only be in the short term.
Isn’t this market manipulation?
The subreddit Wall Street Bets may be open to accusations of market manipulation. This could lead to Reddit itself or a regulatory agency closing the group. This is only a likely outcome if the stock crashes and a lot of investors complain, which is more than possible. This boost in small trader call buys causes gamma hedging which involves buying the underlying security to avoid risk similar to what market makers do to manipulate prices to increase. This market manipulation isn’t accountable to one individual so is likely to become a big issue.
The GameStop bubble is a fantastic example of how retail traders can influence markets and cause growth that isn’t based on fundamentals. While some players are winners, others are losers. This just proves the risk playing with stock markets bring. Learn to trade risk-free with BullBear.