Financial analyst breaks down GameStop stock frenzy

Danny Lacey: Hello, Alex! Thank you for having me. My name is Danny Lacey. I’m a financial advisor with Kramer Wealth Managers, at two offices in Maryland and here in Texas. I’m currently here in Austin, Texas.

Alex: There has been big news circulating about the GameStop stock frenzy. First, can you try your best to simplify what’s going on in ASL?

Danny: Yeah, a lot has been happening in the past two weeks with GameStop and a group of Reddit users, and other social media platforms with the goal of… They’re noticing that GameStop has a high short interest coverage. That means many hedge funds and big investors feel that GameStop will go down and fail because it’s considered a struggling business during Covid-19, since it’s a mall-based store. Nobody is going to the mall anymore, so to speak, and large investors expected GameStop to decline in its business so they put in shorts. The Reddit group and other social media channels bought stocks to hurt the large investors, like hedge funds, for example. Because if you buy more shares, the price goes up and forces them to lose money.

Alex: Can you explain what the terms “shorting” and “short squeeze” mean?

Danny: As for shorting… I want to explain that shorting sales is one of the most risky kinds of investments. So it’s not often recommended for any novice investor to try. The potential of losing money is huge. It’s huge. So, what “short selling” means is - suppose I buy stock and I expect the company to hopefully do well in the future. So, I buy low and sell high expecting it to go up. So, there is a group of large investors such as hedge funds who expect that maybe some companies’ business will get worse, so they try to profit from the price drop. So, they go ahead and borrow shares of that company and sell them. If the price goes down they decide to buy shares and then return them because they’re borrowing in the first place. With low prices, they buy the stocks and return the shares. So, they profit from the differences in costs. So, if I short GameStop, for example, and feel that they’ll go down but they happen to go up in the opposite direction of what I expected, I have to… Because I borrowed money, I can’t borrow it forever with no limit. You have to cover what you borrowed. If that company’s shares go up then that forces me to buy it at a higher price. I lose money. So, that forces me, because I borrowed from large investors, to cover by buying shares at a higher price and then it keeps going in a frenzy. But that tends to settle down later on at specific times.

[Sponsored Video from Sorenson: www.sorenson.com]

Alex: It feels like a revolution. Suppose a new social media leader appears in the future - for example, if I decide to use Daily Moth to ask everyone to please buy this specific stock, would that become illegal in the future as a new rule?

Danny: It is illegal now. There are regulations and rules against that. You would be doing that with the intention to profit from people’s purchases of stocks. Leading that sort of activity is against the regulations and rules. Now, with Reddit, it’s interesting how people share information anonymously. You don’t see their real names. That’s an interesting situation for me to see right now.

Alex: Who is the police - the SEC? Are they the cops here?

Danny: Yes. The SEC will oversee and check social media comments, and how Robinhood has been operating their business. They will look at everything and maybe establish new rules going forward.

Alex: Some feel that Robinhood has a relationship with those large Wall Street brokers to prevent this from happening because it looks like people will continue to buy more GameStop stocks so it’ll continue to rise. There’s no limit, so some feel that they are blocking this. What is your view on that? Is that a shock, or is that standard for the stock market to do that? Can you explain that?

Danny: Robinhood blocking and setting restrictions on specific stocks is very unusual. They should be open and free, to allow people to buy and sell. There could be a number of reasons why they do that, like to prevent people from jumping in and potentially lose their money, or they might not have sufficient capital to make sure trades and volumes run smoothly. So they might be putting a hold on that until they get sufficient capital to ensure the trade happens more smoothly. The more volatility goes up, the more requirements there are for brokerage firms to have higher capital to ensure that trade happens more efficiently to buy and sell. And I feel that we will learn more about the reasoning behind their decisions within a few weeks.

Alex: Now, for people who might have already been involved in buying GameStop stocks, like a Deaf person for example, they would have made a profit. Now, should they try to sell before the bubble bursts or should they hold on to it? Some say they should hold on to them and not sell, for pride and loyalty reasons, or in a financial sense.

Danny: We don’t comment on what you should do on specific stocks. I think with investments, you have specific goals and time frames, and your comfort level with the risk. Use all of those factors to guide you with your decisions in your investments. So, I think it goes back to the importance of doing research on what the company is about, such as GameStop. Is there potential in the future? Could the mall-based store become an online store? There are a lot of good questions to research, and now, the current prices of GameStop as of yesterday had a big drop, and today it looks like it’s going up again. I would look at the bubble, meaning it’s easy access to money and it’s easy to borrow money from. So I would be cautious. It could take a steep fall any time. You know, with the herd mentality, it’s worth remembering that at some point there could be a cliff and the herd will spill over it with losses.

Alex: Thank you, Danny!

Disclosure: "Securities and Investment Advisory services offered through FSC Securities Corporation, member FINRA/SIPC. Kramer Wealth Managers is not affiliated with FSC Securities. The opinions are those of Daniel Lacey and not of FSC Securities. Nothing in this video should be construed as an offer to buy or sell any security nor is it a recommendation to buy, hold, or sell any security. Investing involves risk including the potential loss of principal."