By now, you have likely heard the news about the stock price soaring in the unlikely company of GameStop. GameStop is a publicly-traded retail company that specializes in selling videogames in their brick-and-mortar shops. The company’s stock had been steadily declining until the recent surge. A company with a net loss of $275 million dollars had an increase of over 1,700% in their stock price, indicating the rise had nothing to do with the financials or stability of the company, and more to do with investor behavior.
The reason for the surge lies behind the coordination of individual investors (someone who invests on their own behalf) through a social media platform called Reddit. These retail investors have targeted GameStop as a reaction to hedge funds that had shorted the company. In this example, the hedge funds took a short position in GameStop, borrowing shares of the stock with the expectation that the stock will continue to decline, and the market value will be less (cheaper) when it is time to pay back the borrowed shares. When holding a short position, if the stock does not behave the way you had anticipated and it instead increases, the loss is unlimited, and you may be in a position to buy it back quickly to limit the potential losses. Which is exactly what happened with GameStop, the momentum of the individual investors drove the price of the stock up resulting in the hedge funds needing to pay back the borrowed funds at a higher price, ultimately resulting in the stock price rising even higher, this is called a “short squeeze”.
What Should You Do?
Many investors saw the increase and felt pressure to reallocate funds to this highly publicized stock. The unusual activity we’re seeing with this heavily shorted stock is making big headlines, but that doesn’t necessarily mean it’s cause for reallocation within your own portfolio. It is, however, a good reminder to determine your tolerance for investment risk.
Risk Tolerance 101
There is a degree of risk in any financial investment, and this is especially true when targeting individual stocks. There are no guaranteed winners or sure losers, either. How comfortable you are with the latter may give insight to your risk tolerance. You can think of risk tolerance not only as how much you are willing to lose on your investments but rather how much uncertainty you can live with from day to day. Do you tend to watch the market daily? If so, do the short-term upswings and downswings bring you excitement, or dread, and stress? Questions like these will help you determine your ability to take risk in your investment portfolio.
If you’re not sure whether or not your investment portfolio is in line with your risk tolerance, ask your advisor.