What did we learn in the aftermath of the GameStop frenzy?


One of the most interesting stories in the news this year occurred in January when small time investors strategized on social media to harm the GameStop shorting positions taken by hedge funds.  

The public has always been skeptical of these corporations and their practices.

A common belief is that hedge fund companies have colluded over the years and profited from shorting stocks, so when users on Reddit’s WallStreetBets strategized to drive the price of GameStop up at the expense of some hedge fund investors it seemed like poetic justice, and when they succeeded it became a feel-good story.

When the story first broke it appeared as though all the hedge funds were heavily shorting GameStop and it appeared as though all the message board posters who purchased GameStop made a killing.   

It seemed to make sense that the army of message board posters made a killing, because when GameStop’s price surged, hedge fund investors who took a short position were forced to cover their short positions causing the price to soar even higher.

Now that the dust has settled somewhat from the GameStop trading frenzy the reality of what happened seems to be a little different than what first appeared.

It turns out many of those message board posters who bought and sold Game Stock during the surge may have lost money and many of the biggest beneficiaries of the surge were the hedge fund and other investment professionals.  

While it is ironic that many of those in the Reddit community who planned the surge lost while many institutional investors profited it is not surprising from what I read.

It turns out, those that benefit the most from the chatter on message boards are more likely to be the hedge funds while those individual investors who actively respond to message board posts are more likely to under-perform.

One reason hedge fund investors benefit from social media chatter and message board posts is that hedge fund companies pay outside companies to scan social media to see what is being devised by retail investors.  Also, some hedge fund companies create their own social media monitoring algorithms to anticipate what is being planned.

The reason individual investors who listen to message board posts under-perform may be because they are beaten to the punch by the corporate investor who uses those sophisticated social media scanning programs.  

Whatever the reason for the underperformance it has been proven the individual investor does not benefit by making his or her investment decisions based on message boards posts.

In a study of 65,000 individual investors by financial experts Brad Barber and Terrence Odean it was revealed that those investors who actively bought and sold the stocks recommended from message boards under-performed those investors who bought stocks the traditional way of buying and holding onto the stocks.

So, in the aftermath of the GameStop frenzy, it seems that the trend of buying message board hyped up stocks through apps like Robinhood and then trying to sell them right away for a profit is not the wise investment move. 

Yes, some hedge fund companies like Melvin Capital, who had to receive a bailout, lost a lot of money and some small investors earned a lot of money during the GameStop surge but that is not the norm.

For example, the portfolio of hedge fund company Mudrick Capital gained 9.8 % in January due in part to the $200 million it gained from stocks driven from Reddit posts.  Hedge fund Servest Management gained $700 million in profits from buying and then selling GameStop during the frenzy.

The Melvin Capital news made for the more interesting story but is the less likely to happen story since professional investors rarely lose to the average joe investor.

So as boring as it sounds the traditional way of investing which involves diversifying and holding onto investments is still the most likely way for regular individuals to make money.

It did seem for a moment however that the new trend of following message board posts provided a quick way for the average joe to strike it rich, and there is nothing wrong with being able to dream.