The Truth About Wall street Bets
It seems like we have developed a tradition where every year starts with a financial disaster.
2020 started with a massive stock market crash. 2021 with retail investors pushing hedge funds
to lose billions of dollars and putting the entire financial system
upside down. I am just curious what 2022 is holding for us!
The fed is going to announce that it's going to launch its own crypto currency?
I wouldn't be surprised.
GameStop's stock price surged more than 1,700% instantly, driven by a group of amateur investors
on Reddit who organized a revolt against hedge funds that bet against the company.
The best part is that these hedge funds that seemed like no one can beat them at their game
lost billions of dollars. A bunch of Reddit users destroyed multi-billion
dollar hedge funds that spend millions on the latest softwares, best accountants,
and analysts to predict the market. They even caught the eye of the White House in the process.
Melvin Capital, one of the hedge funds that shorted GameStop, lost 53%. It started the
year with 12.5 billion dollars and ended January with just 8 billion dollars.
It's estimated that short-sellers lost nearly $13 billion on GameStop alone so far this year.
I guess these hedge funds will think twice before shorting another stock.
However, most retail investors who purchased the stock at 300 or 400 dollars or above
ended up losing most of their money since platforms like Robinhood restricted trading.
To understand what really happened with GameStop,
we have to understand why hedge funds shorted game stop in the first place?
How is it possible to short more stocks than the number of stocks that exist? Should you trust
WallStreetBets? and how to avoid the biggest financial mistake that most investors make?
We will answer all of these questions and many more, but before we do that, here is a little
disclaimer - this is not financial advice, and everything that's said in this video is for
educational purposes. In order to make the best financial decision that suits your own needs,
you must conduct your own research and seek the advice of a licensed financial advisor.
And now, give this video a thumbs up for the youtube algorithm, and let's get right into it.
1. shorting - a tool for the Ultra-Rich
You probably heard about hedge funds, but you don't know for sure what they do
because they are not allowed to market themselves since they are not regulated.
That's why very few people know how hedge work.
Hedge funds are made by the rich for the rich to make rich people richer and avoid
taxes - that's all that you need to know. If you have never invested through a hedge fund before,
that's alright because you need a net worth of a least a few hundred million dollars.
Unlike ETFs, they take a percentage of the profit besides a percentage
of the total assets you invest in. That's why they try to maximize profits for their clients.
The most common investing strategy you probably heard is - buy low and sell high. That's how you
and I invest, but the ultra-rich like hedge funds invest by reversing this strategy.
They buy high and sell low. That doesn't make sense at first glance, but it's simple.
Let's say you expect a certain stock to decline like Intel because you know that
Apple who is their biggest client, will announce next week that they will no longer buy Intel chips
and make their chips in-house. So you pick up your phone and call your broker.
You borrow from him a single intel stock that costs 100 dollars and instantly sell it in the
open market for 100 dollars. Congrats!
Now you have 100 dollars in your pocket, but you still owe your broker one intel stock.
Let's say you are right, and Next week intel's stock price drops to
70 dollars. You use that 100 dollars to buy one intel stock for 70 dollars since the
price dropped and return it to your broker and pocket the difference.
Congrats! You have made 30 dollars out of a fall of stock!
It sounds simple in theory, but it's extremely difficult and risky in practice.
What happens if you are wrong? What if the price doubles overnight?
You still have to return that single intel stock to your broker?
Now you have to buy that stock back for 200 dollars to return it to your broker.
When you buy a stock and try to sell it when it rises,
the maximum that you can lose is the amount you invested in, but not in the case of shorting.
If the price keeps rising, your losses keep rising. Theoretically, you can make
unlimited losses since, theoretically, the stock price can rise indefinitely.
So when hedge funds realized that GameStop is struggling,
they decided to play around with its stock and bet against it, and shorted 114% of its stock.
What? Wait a second!
How can you short more stocks than the number of stocks that exist?
It's complicated, but here is the simplified version.
Let's say Elon owns 1 GameStop stock. His broker lends his (Elon's) one share to a
short seller Jeff. Jeff borrows that stock and sells it in the open market to Warren.
Warren doesn't know that Jeff actually borrowed that stock, so Warren's broker lends his share
to another short-seller Bill who then goes and sells that share to another investor. The
exact same share now has been shorted twice. This scenario shouldn't have happened, but it happens.
So the Reddit user who was investing in GameStop since the fall of 2020 realized that
all of these hedge funds shorted over 100% of GameStop shares,
which means if everyone starts buying GameStop, the sock will keep rising, and hedge funds
will have to buy these shares no matter how expensive they get to exist their position.
But that will drive the price higher, which will attract more investors, which will again
drive the price higher to the point where these hedge funds will either go bankrupt
or at least buy back these shares at an unbelievably high price. So GameStop's
stock price surged more than 1,700% instantly. Theoretically, it made sense to buy GameStop
because short-sellers had to pay interest on the borrowed stocks.
If everyone held their position and didn't sell, hedge funds would have kept proposing higher and
higher price. Gamestop could have easily crossed a thousand dollars, but something went wrong.
Platforms such as Robinhood and others restricted retail investors from buying more GameStop shares.
That's insane!
Of course, they explained their actions by saying that they were protecting their clients,
but I don't personally buy that. That could be the reason partly,
but I think there is a lot more to this than we know. Who knows, maybe one day we will find out.
Trading - another form of gambling
Here is what I don't like about these kinds of investments. First of all,
it's not investing - it's trading. And it's not based on any data or logic.
The people who invested in GameStop and similar companies are not investing because they did
not do fundamental analysis and expect the business to grow, it was pure Pump and dump.
The problem with that is that, no matter how high the stock price will rise, it will crash and fall
back to where it started because the company didn't change or grow. At some point when the
price reaches a certain point, early buyers will sell which will drive the price down,
which will force other investors to panic and sell which will further drive the price down,
which will force more investors to panic and sell and so on until most people who purchased
the stock after the hype will lose at least some of their money if not all.
You could be lucky, you could be one of the early buyers, but chances that you will lose
money especially if you invested once it was already all over the news are way higher.
When something like that happens, when everyone is making money,
when it's all over the news, it's really difficult to control yourself.
The feeling of missing out will push you to invest even if its too late. I have had that feeling
multiple times, but I try my best to control myself because if I feel like I am missing out,
chances that I have missed out are already 90 percent. So even if it's a great opportunity,
I would rather miss it than lose the money I have earned with my blood and sweat.
I am not saying you shouldn't take risks or invest. Investing is great. I do invest
myself. This channel is about investing. But when investing is based on facts and data, Chances
you will make money are way higher and most importantly, you can sleep peacefully at night.
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