3 Things I Learnt About Gamestop Wall Street Bets VS Hedge Fund Short Sellers

3 Things I learnt from the Gamestop Saga

It is 29 Jan 2021. Gamestop (GME) share price is $325. It has gone up a long way since early January when price is around $17. The battle is still on. Several brokerage companies like Robinhood has started to restrict trading on GME. So much for a company that believes that everyone should have access to the financial markets. With this, I believe there might be more interest going towards Bitcoin.
If you unsure what happen, do check out the first article How Gamestop is better “investment” than Tesla, where we explain the hype on GME.
Disclaimer: I do not have any position in GME/Bitcoin. Indeed, I have “missed” out on the huge runs of those companies but time will tell. Here at Wealthdojo, we seek to understand what has happened fundamentally. Even in the insane movement in the stock market, we aim manage our wealth in a logical and systematic way.
3 Things I Learnt About Gamestop Share Price

3 Things I Learnt About Gamestop Share Price

 

The Update

Things were not pretty over the last few days.

  1. Hedge Funds had to closed their short positions taking in huge losses. Melvin Capital (the guys that have shorted GME) have not announced how much losses they suffered but Citadel and Point72 have infused close to $3 billion into Melvin Capital to shore up its finances. They have also deny going into bankruptcy but supposing have been bailed out.
  2. Several brokerage companies started to restrict trading. On 28 Jan, they only allowed people to sell their shares of selected companies. On 29 Jan, they allowed people to buy only one share of selected companies. This came as an outrage as if you restrict people to only sell. There is only one direction the company can go.
  3. Robinhood started to draw up to $600 million from their line of credit. They have also raised more than $1 billion from existing  investors. It is to pay customers who are owed money from trades and also fulfil regulations. They probably did not manage risk properly by allowing those shorter to short too much.

From this episode that is still ongoing, I hope to share 3 important lessons that we can learn as retail investors.

 

Leverage

Time and again, this word comes out to haunt the financial market. If you can remember the 2008 financial crisis, lines of credit is so easily available that even a prostitute can take a dozens of mortgage loan (Unverified information from Netflix: The Big Short).

When you leverage, you are using money that you don’t have to purchase a stock.

Leverage example:

You have $100,000. You want to invest in ABC shares (assume it is $1) because you believe the share price will double for whatever reason in the next few days. You leverage by borrowing another $100,000 to invest paying an interest (we are going to ignore interest in the calculations). You buy 200,000 shares using your $200,000.

When ABC shares doubles (now $2), you would have $400,000. You pay back $100,000 and your portfolio is now $300,000.

If you didn’t leverage and borrow, your portfolio only grows to $200,000.

Your money grows “faster” when you leverage.

However, if ABC shares drops to 0. Your original $100,000 is now 0. However, you now owe $100,000.

If you didn’t leverage and borrow, your portfolio just suffers the maximum lost of $100,000 but you do not owe people’s money.

The above is a 1:1 leverage. It is possible for you to have a 50:1 leverage in the financial market. Imagine how scary it is if the trade don’t go according to plan. That’s 50x of $100,000.

 

Investing with margin or leverage is the fastest way to lose all your money. We won’t deny the fact that it is also the fastest way to make more money. Ideally, you should only invest with the money you already have. I believe we will see how this spans out in the days ahead especially if there are big hedge funds using leverage in their GME positions.

Prisoners Dilemma

I never thought I would see this happening after my university days. Readers of Wealthdojo will probably know I’m a behavioral economics fan. Seeing prisoners dilemma play out in real life is somewhat very fulfilling.

Let’s set the context first. When the brokerage stopped people from buying. All you could do was to sell the stocks. Hence, it became a situation of sell or don’t sell among the retail investors.
3 Things I Learnt About Gamestop Prisoners Dilemma

3 Things I Learnt About Gamestop Prisoners Dilemma

I have created a payout table to facilitate the discussion on the prisoners dilemma.
3 Things I Learnt About Gamestop Prisoners Dilemma Part 1

3 Things I Learnt About Gamestop Prisoners Dilemma Part 1

Shareholder #2 best response is to sell. This is because if Shareholder #1 were to sell, Shareholder #2 is better off selling than not selling (2 > 1). If you sell but other investors don’t sell, you win but other investors lose. If Shareholder #1 were to not sell, Shareholder #2 is better off selling than not selling (5 > 4).

3 Things I Learnt About Gamestop Prisoners Dilemma Part 2

3 Things I Learnt About Gamestop Prisoners Dilemma Part 2

Similarly, Shareholder #1 best response is to sell. This is because if Shareholder #2 were to sell, Shareholder #1 is better off selling than not selling (2 > 1). If Shareholder #2 were to not sell, Shareholder #1 is better off selling than not selling (5 > 4).

3 Things I Learnt About Gamestop Prisoners Dilemma Nash Equilibrium

3 Things I Learnt About Gamestop Prisoners Dilemma Nash Equilibrium

The Nash Equilibrium for this game is for both of them to sell getting a payoff of (2,2). Logically, both shareholders will sell.
Although (4,4) is the most ideal for them, it requires all the GME investors to coordinate and don’t back out on the deal. It will certainly play on the motivation on the GME investors to stick on with don’t sell.

Motivation

3 Things I Learnt About Gamestop Wall Street Bets VS Hedge Fund Short Sellers

3 Things I Learnt About Gamestop Wall Street Bets VS Hedge Fund Short Sellers

I have learnt that in investing, different people will have different motivation. I find it bizarre for people to randomly ask someone on their opinion and whether to invest in the stock market at this moment of time.

If you ask a trader, he will say yes because the S&P is upward trending.

If you ask a value investor, he will say no because valuations are crazily rich.

If you ask a growth investor, he will say yes because there is still growth.

If you ask Warren Buffett, he will just buy back his own shares.

If you ask Elon Musk, he will tweet Gamestonks!

If you ask me, I will sit at the sidelines and continue to collect excellent companies and a sensible price.

For the people at Wall Street Bets, they are there to send a message.

 

If you decide to follow any of them, make sure they have the same motivation as you. Otherwise, you might find yourself in an awkward position.

 

Final Thoughts By Wealthdojo

When you thought 2020 was an epic year, 2021 came as another surprise. This episode definitely hasn’t closed yet. Who knows this might be a trigger for another financial crisis. If it comes, the question is “are you ready?”.

 

For those of you who want to kick start your Wealth Management journey in 2021, why not consider joining my telegram channel?

Join my Telegram Channel for a tip a day! In Wealthdojo, we dedicate a small amount of time daily for learning new things. Continuous learning is one of the greatest secrets of success.

For those of you who want to turbocharge your journey, contact me at chengkokoh@gmail.com. I would like to hear from you what your experiences are currently and from there, we develop a plan specially catered just for your journey.

We wish you all the best! Stay Safe and Take Care!

Chengkok, Sensei of Wealthdojo.

 

Cashback or Airmiles

Cashback or Airmiles: A Behavior Economics Analysis

The long debate between Cashback or Airmiles has been going on every since the existence of Airmiles. In Wealth Management, there are tons of literature whether Cashback or Airmiles which each camp strongly defending their point of view. I will be using a behavior economic lens to analysis this after being inspired by Pete who recently wrote an article on his decisions to choose between Cashback or Airmiles.

Will you choose “up to 2% of cashback” or “up to 4% of airmiles”?

Cashback or Airmiles

Cashback or Airmiles: I miss travelling

To answer the above question, I have to remodel the question so that we can use a behavior economic theory to answer it. These are the following assumptions that I will be taking.

Assumptions

  • I will assume that Pete receive the full 2% and 4% (noted there might be conditions to get up to the intended rates)
  • I will assume that Pete receive $200 and $400 (in monetary form)
  • The probability of using the cashback is 100% (you will definitely be able to use the money)
  • The probability of using the airmiles is xx% (airmiles might be devalued/you can’t fly/points expire etc)
  • The traveler is paying the airfare out of their own pocket. (Thank you Philip Walsh for your contribution)
  • I recognize that airmiles are a specific spend in the travel category but will be treating it as if it is equal to cash

 

Which will you choose? 100% of getting $200 or xx% of getting $400?

One common way to approach this problem is using the concept of expected returns. In this case, if there is a chance of getting more more an 50% of getting $400, it is logical sense to go for the latter option. However, emotionally we might not feel the same.

In my previous sharing on Self Care and Wealth Management, I wrote about emotions being part of our decision making process and it is the same in this case. The behavior economic concept that I would be sharing with you is the certainty effect.

 

The Certainty Effect

Behavior Economist Dr. Daniel Kahneman propose a concept called the Fourfold Pattern. 

Cashback or Airmiles Fourfold Pattern

Cashback or Airmiles Fourfold Pattern

While we are not going to go through all four patterns, the behavior pattern that I would illustrate today’s case is in the top left section. These are the choices.

Choice #1: 95% of winning $10,000
Choice #2: 100% of winning $9,000

Clearly, choice #1 is ideal because the expected payout is $9,500. However, most people will choose choice #2 because the emotion called fear of disappointment. They rather “lock in” the profits in a high probability scenario. In certainty, most people are risk adverse.

 

The Final Verdict

In a real life scenario, we are unable to set controls in our experiment but we can draw inference from the certainty effect.

Choice #1: 100% of $200
Choice #2: xx% of $400

I believe most people will choose choice #1 because they are motivated by the fear of disappointment. There are too many uncertainty such as airmiles depreciation, airtravel resumption and expiry of points with choice #2. That being said, airmiles are can only be used in a specific category while cash will.. be cash.

I recognise that there will be some that will continue to choose choice #2 and may be motivated by other behaviour emotions.

How about you? What choice will you make?

 

No one will care about your money as much as you do.

In Wealth Management, it is important to Pay yourself first. Beware of scams. Before you invest in any company or popular investment opportunity, be sure to do your own due diligence. If you wish to learn more about investment, I hope to nurture genuine relationships with all of my readers.

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