It’s quite remarkable how retail investor (at-home traders and investors) behavior helps professionals get a gauge on the market’s sentiment and health. I’ve been reading all across social media platforms about what stocks people have been trading, many of whom just got started ‘day trading’. I’ve even seen threads on sports boards for my beloved Florida State Seminoles about what stocks are the flavor of the week and how much money is being made. Self-proclaimed experts seem to be rising by the masses. As this type of activity runs rampant through the markets, it screams a signal to us to prepare for some volatility that the market is due for.
An investor group on Reddit is being given the credit for coordinating a buying spree on the market’s most shorted names including GameStop. The idea behind this is to drive the price up enough to trigger a barrage of institutional (mostly hedge funds) short-covering (buying to cover the short) to get out of their bearish bets as prices rise. The most dangerous aspect about shorting a stock is that losses can be theoretically unlimited. Just as a panic sell-off can be created, panic buying can ensue in an equal or even more aggressive of a fashion. The result of this has been huge losses declared by some of the largest hedge funds.
This activity has proven a very interesting concept: that retail investors in 2021 have the ability to manipulate the market in such ways that institutions have been famous for over the years. Certainly, an SEC investigation is forthcoming, and responsible parties will be held accountable. Add options bets to this fuel, and the effect is even more magnified. This type of activity is absolutely a new phenomenon.
I’ve been saying for quite some time that the current tech savvy era we are in will yield more program trading, easier access for retail investors to participate, and thus market swings can be even larger on both the upside and downside. Our philosophy of establishing ‘guard rails’ around equity portfolios helps to mitigate large market swings as hedging helps to insulate equity positions and quants track trends and technicals to enter and exit the market based on proprietary factors. Emotion is removed from the process and we rely on math to do the work for us. Of course, when things begin to look like they have in the last few days, having some cash on the sidelines to capitalize on market corrections is always helpful too. We’ve had some very constructive calls with clients on this speculation mania, and have advised to proceed with caution. We do believe that any corrections should be relatively shallow as we remain constructive on the economy and stimulus.
As always, if you have questions, we’d love to hear from you.