What did we learn from Gamestop?

Now that the excitement has passed, what can we learn from the Gamestop saga?​​​

Don’t be seduced by the lure of easy profits

​Many novice investors who had never previously taken an interest in financial markets suddenly became transfixed by every movement of Gamestop’s stock price and every development in the story. They believed they were investing in a sure thing, with the added lure of being able to profit at the expense of hedge funds.

​But in the end, a lot of those that invested in Gamestop after the initial hype simply ended up losing money. The stock price is still up some 1850% from the lows of summer 2020, but the huge gains that seduced so many came in the initial wave. Gamestop hit its peak at the end of January 2021, and since then is down 84%. Along the way there have been a number of rebounds, but each has fizzled out, with the stock price continuing in a downtrend.

​Those who hoped to see the Gamestop share price make further huge gains have ended up holding a dud.

​Don’t put all your eggs in one basket

​As with the cryptocurrency mania, many investors put all the money they could into Gamestop. They had seen the huge gains made in the second half of 2020, and expected this to continue. In order to maximise their potential profits, they ignored the importance of diversification, and suffered heavy losses.

​Sensible investors avoid committing too much of their funds to one investment, instead spreading their funds into a number of different investments. While this means they won’t reap the full potential rewards of huge gains in one area, neither will they suffer excessive losses if one investment performs poorly.

​A unique set of circumstances

​The ‘meme stock’ craze of 2021 took place because of a rare confluence of factors. Stocks like Gamestop and AMC had been heavily shorted by institutions, and thus their stock prices were vulnerable to ‘short squeezes’, where a rash of buying causes the price to climb, forcing short sellers to close their positions, which in turn pushes the price higher, and so on.

​But such situations do not occur too often, and are usually found in illiquid stocks. When the meme stock crazed moved into other asset classes, it was rapidly discovered that it was not possible to drive the same kind of huge upside as was seen with Gamestop.

​Once more, investors who jumped in without doing their research suffered heavy losses.

​Beware the hype

​Financial manias are a part of the investing world. They have existed since the Tulip Bubble of 17th-century Amsterdam. ‘Meme stocks’ were merely the latest incarnation of the belief that ‘get rich quick’ schemes could deliver huge returns.

​Unfortunately, the meme stock craze will not be the last mania to take hold in markets. Sensible investors need to be aware of such events, and avoid becoming seduced by the lure of apparently effortless success. If something looks too good to be true, it probably is.

​Know your risk limits

​Humans naturally focus on how much they could make from an investment. But as experienced traders will tell you, the most important thing is avoiding losses, or more accurately avoiding large losses.

​Any investment should have a defined exit point, at which an investor or trader will close the position. This can be done through having a pre-determined level to close the trade, either manually or (the best way) by setting a stop loss that will close the position at a defined level.

​This stops losses from becoming too large, and is a vital step on the path to investment success.