That didn’t last long

The GameStop story isn’t over yet, but while the hangover clears on one of the biggest stock market parties ever, it is time to get back to reality. Since last week (January 27), the share price of GameStop has fallen 73% from $347.51 to $92.41.

A few hours after I published last weeks article, no fee investment apps such as Robinhood restricted purchases of stock like GameStop. This saw diametrically opposed politicians like Alexandria Ocasio-Cortez and Ted Cruz cry foul that retail investors weren’t allowed the same access to the markets than institutional investors. The reason for the restricted trading was a lot more boring than a conspiracy of protecting Wall Street investors from an uprising lead by the retail investor.

The Clearing House

Anyone who has bought stocks, ETFs of funds will know that it usually takes a few days for the trades to show up in their account after they made. That is because when a trade is made, it can take up to two days for it to be legally settled. A clearing house stands in the middle of the trade and manages the risk to the market if either side on a trade defaults.

By 10am on each trading day, stock brokers are required to put a specified amount of liquid assets (called a margin) into an account with the clearing house.  The amount required is calculated by the clearing house and it is based on the amount of trading carried out by each broker and (this is the important bit) the amount of volatility of the individual stocks invested.

As you can imagine, with the frenzy to buy GameStop stock, their clearing house required more capital to cover the margin on these trades. Robinhood saw their deposit requirement increase ten fold and they simply didn’t have the money to cover their margin, so they had to restrict trading. They raised $1 billion from lines of credit and investors to cover their margin. They raised a further $2.4 billion from investors to grow the company.

Markets are efficient

The GameStop stock was always going to fall back down and I suspect it will continue to fall back down to around $10 or lower. Ironically, I have never seen a better opportunity to short a stock! Why do I think the share price will fall further? Because markets are efficient.

What that means is that the share price of a company reflects the value of the company based on all available information. There was no way that a failing company like GameStop was going to continue to be valued at $20 billion when it was valued at $300 million in August 2019, especially when they haven’t done much to reinvent themselves.

Take your profits and enjoy it

Some of the early investors in the GameStop frenzy will still be up but there will be a lot of people sitting on losses. Meanwhile, the hedge fund managers are still getting paid millions to lose money. It is an important lesson to investors to take the profit when it is there and not hold onto “hot stocks” forever. If you are going to be a long term investor, take a much more diversified approach to investing. It is nowhere near as exciting as what happened last week but you don’t want that happening every week with your pension fund or large lump sum investment.

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