You may have heard about the market volatility* and unexpected rise of some stock prices in late January. Even investors who didn’t own any of the hotly traded stocks like GameStop Corp. or BlackBerry Ltd., likely saw a brief change in the market value of their investments as markets turned volatile. So what happened then and what happens next? Here’s the breakdown.
(*Market volatility refers to the dramatic swings or ups and downs of the stock market.)
What happened with the stock market and what does GameStop and Reddit have to do with it?
GameStop became a favourite of the WallStreetBets Reddit group, whose eight million members consist mostly of young, anonymous day-traders. They drove up the stock price from US$4 a year ago, to over US$400 at its peak in late January.
At the same time, hedge funds had been shorting1 GameStop and a number of other stocks of interest to Reddit’s members. This caused a short squeeze2 and forced the hedge fund managers to buy these stocks at much higher prices.
1Shorting or short selling happens when an investor borrows shares of a company and sells it on the market. In this case, the investor often expects to buy the shares back later for less money.
2A short squeeze happens when the price of stock rises, forcing traders who had shorted it to buy in order to prevent even greater losses.
Was the Reddit group’s investment strategy too risky?
Clearly some of Reddit’s day-traders did well, but GameStop stock fell sharply in the early days of February.
“It’s intoxicating to see how easily valuations can run up on a crowded trade into a relatively small stock,” says SLGI Asset Management Inc. portfolio manager, Kathrin Forrest. “But it’s important to consider how this plays out as the party moves to another venue and the crowd heads for the exits.”
For most investors, chasing volatile stocks is not a great strategy, because it is high-risk and requires close monitoring.
Many professional portfolio managers prefer to play the long game: buy and hold companies that have healthy balance sheets and good future prospects. This requires looking at a particular stock’s value through a critical lens and asking questions such as:
- What are a company’s current and forecasted earnings?
- Does the company’s product or service have a unique, sustainable advantage that the company can protect?
- Is the company in a sector that is seeing increased growth?
If the answers align with the stock’s price, it could be a good investment. But if they don’t, there’s a greater risk that any money invested could be lost.
How Reddit group members made speculative investments with GameStop
On the other hand, what the Reddit members were doing with GameStop and a few other stocks in late January, was essentially speculating.
They looked for stocks that were not expected to perform well, and bet that their price would go up based on internet-hyped demand.
“These are generally stocks that have seen a strong increase in daily volume, options activity and strong price appreciation without a meaningful change in underlying fundamentals,” says Forrest. Stock prices were rising, but there was no sound reason for the rise other than artificially inflated demand.
Is speculating a bad strategy?
Speculating isn’t new, or even all that uncommon. We can look back a mere 20 years or so to the dot-com bubble. Or all the way to the 17th century’s Dutch tulip mania, and other instances in between. And while some people made money, many others lost their shirts.
It’s also important to note that speculating isn’t always seen as negative. Some investors with large portfolios set aside a small amount to invest in unproven companies that:
- have promising ideas or resource assets, or
- seek to capitalize on highly volatile securities.
But given the high risk of losing money in speculative investments, this isn’t a common approach.
What happens next?
This latest example of speculative trading has caused some market volatility. It may have also caused investors to get a little bit more nervous about what might happen down the road. But most investors with stocks (e.g. in balanced or equity mutual funds) see short-term fluctuations in their portfolio when markets are volatile.
So if your financial goals haven’t changed and you have a diversified portfolio,* then you don’t have to be too concerned about market volatility.
(*A diversified portfolio includes various assets like stocks, fixed income, and commodities. These assets may react differently to the same economic event. The value of one may rise while the value of another may fall. This lowers your overall risk because no matter what happens in the market, some assets will still have gains.)
Remember, history tells us that markets grow over the long term. As an example, think of events like the Tech Meltdown in 2000 and the Financial Crisis from 2007-2009. In such cases, the market recovered from downturns and produced gains. And, those who stay invested have realized these gains over the long term.
Get professional help with your investments
Are you still worried about volatility risk or inflation risk? Or maybe you're concerned that your portfolio lacks diversification? Then you may want to consider talking to a professional may help.
This is a good time to reach out to your advisor if you have one, or to find an advisor if you don't. (Many advisors now offer to meet Clients virtually by video chat.)
An advisor can help you:
- make good financial decisions,
- understand what your risk tolerance is,
- match your risk tolerance with your need for long-term growth or income,
- make a plan and build an investment portfolio that meets your long-term goals,
- feel assured in times of uncertainty, knowing you've taken steps to prepare, and
- avoid making emotionally-driven decisions about your savings.
- 5 tips for finding an advisor you can trust
- Important questions to ask an advisor you’re just meeting
This article is meant for information purposes only and is not intended to provide specific financial, investment, tax or legal advice. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by SLGI Asset Management Inc. or any mutual funds managed by sub-advisors. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell securities.
Information contained in this article has been collected from sources believed to be reliable. But please note that no representation or warranty is made with respect to its timeliness or accuracy.
This article may contain forward-looking statements about the economy, and markets. Forward-looking statements are not guarantees of future performance and are speculative in nature and can’t be relied upon.