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

3 Things I learnt from the Gamestop Saga

by with 3 Comments Behaviour EconomicsGeneral EconomyInvestment AccumulationMoney MindsetSpeculation
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?”.

 

Chengkok is a licensed Financial Services Consultant since 2012. He is an Investment and Critical Illness Specialist. Wealthdojo was created in 2019 to educate and debunk “free financial advice” that was given without context.  

Feel Free To Reach Out To Share Your Thoughts.

Contact: 94316449 (Whatsapp) chengkokoh@gmail.com (Email)
Telegram: Wealthdojo [Continuous Learning Channel]
Reviews: About Me

The views and opinions expressed in this publication are those of the author and do not reflect the official policy or position of any other agency, organisation, employer or company. Assumptions made in the analysis are not reflective of the position of any entity other than the author.

 

2021 New Year Revolution

Start a Financial Revolution Not Resolution in 2021

by with No Comment Behaviour EconomicsMoney ManagementMoney Mindset

It is 2021. I find it annoying that there are still tons of articles out there will tell you to write down New Year Resolutions such as paying off debts, spend less than you earn, set a budget, drink less Starbucks etc. It is 2021. You already know that. In the new era, it is not about finding information. It is also not just about finding the right information (6 Steps Wealth Karate). In the new era, it is making use of the right information easily.

Some of readers have shared with me they fall short of their 2020 financial resolution because they have the lack of clarity or strategy. I wish to take this one step deeper. It is not that you did not know what to do. It is also not that you did not know how to do. However, psychologically it is not easy.

In this article, I will be writing how to start a financial revolution so that you can create the right environment to win psychologically.

Now, all this can only be done after done this: You can only start 2021 properly after doing these 3 things. Start here first.

 

2021 New Year Revolution

2021 New Year Revolution
2021 New Year Revolution. Photo from Huffpost.

To put yourself in the right environment, you need to first understand yourself. I summarized this by a quote that I frequently used.

There are three things extremely hard: steel, a diamond, and to know one’s self. ~ Benjamin Franklin

After understanding yourself, then you can create the right environment for success. You want to create a system that is psychologically easy to win. Here are 4 ways to put things in your favor psychologically. I bet you will not be able to find this easily elsewhere.

 

#1: Set Weekly Budgets Instead of Monthly Budgets

Ever wonder how we could save so much when we were students but not now? The trick is that most of the students are given a weekly allowance instead of a monthly one. When students then track their budget on a frequent basis, this creates a saliency effect. The more we noticed something, the more we are aware about it, the more we will review it.

For majority of us, we are now following a monthly budget. We don’t review it as often and so become surprised when we overspend during the 3rd or 4th week of the month. If budgeting is an issue for you (psychologically), set weekly budgets.

If you are planning for big ticket items, you can consider using this to help you. If you have spending issues, do read our Ultimate 4 Quadrants Shopping Guide.

 

#2: Audit Your Finances

Just like teachers marking the examinations paper for students, or MAS checking the quality of consultant’s advice, we feel a certain pressure and would want to make sure that our work is correct. It is the same for finances. It has came to my attention that most people don’t audit their finances at all. This means we will not know if we are on the right track when it comes to finances.

Auditing your finances is very simple. Just like a teacher marking each question, ask yourself if an expenditure is reasonable. Notice that I mentioned reasonable rather than “correct”.

For example, one of my friend have been subscribing to Spotify for $9.99 a month. He initially subscribed to Spotify because he wanted to listen to ads-free music on the way to work (I think that’s pretty reasonable). However, in March 2020 he has started to worked from home and he realised he has forgotten about it and is continuing to pay for Spotify but have not been using the service for the past 7 to 8 months. He has now stopped the payment but will be taking it up again when he needs to travel to work again.

I recommend you to audit your finances once every half a year. Spot those that are “unreasonable”. They could help you save a lot in the long run.

Financial Revolution 2021 Audit
Financial Revolution 2021 Audit: Source: CIA

 

#3: Allocate More

Do this only after you have already prepared your emergency funds. After that, yes. Allocate more.

It is very natural to feel happy when you see your bank account increasing. However, you will only realised the effects of inflation after many years. I strongly recommend you to allocate more when you have the opportunity. Whether it is an insurance policy, an endowment policy, an investment policy or buying into stocks or property, I encourage you to add more when the time is right.

To psychologically help you, you can employ certain tools such as regular saving plans to deduct a similar amount every month. This automation will help you allocate more and yes be on your journey to financial freedom.

 

#4: Sell Things That Are New That You Don’t Want

Look around your house right now, I believe that there will be some items that have been there sitting in the cupboard for a while. Be it a gift from a friend or a book that have not been touched or a lucky draw that you have won, there will be some item that has been around but have not been used.

Take this opportunity to do some spring cleaning and make some money. Put it on carousel. You will be surprised at how much money you can make out of your own room.

Before selling them, ask yourself 3 questions.

  1. Have you used it for the last 3 months?
  2. Will you use it for the next 3 months?
  3. Does it have sentimental value?

If those answers are no, those items will not be missed. This is where I personally sell my own items. Check out my Carousell items to give yourself an idea.

 

Final Thoughts By Wealthdojo

Don’t start a resolution, start a revolution! If you haven’t been successful in your financial journey, just pick one of the above and commit to it for the next 3 months. I assure you that you will look back at 2021 and be proud of yourself.

Chengkok is a licensed Financial Services Consultant since 2012. He is an Investment and Critical Illness Specialist. Wealthdojo was created in 2019 to educate and debunk “free financial advice” that was given without context.  

Feel Free To Reach Out To Share Your Thoughts.

Contact: 94316449 (Whatsapp) chengkokoh@gmail.com (Email)
Telegram: Wealthdojo [Continuous Learning Channel]
Reviews: About Me

The views and opinions expressed in this publication are those of the author and do not reflect the official policy or position of any other agency, organisation, employer or company. Assumptions made in the analysis are not reflective of the position of any entity other than the author.

 

Cashback or Airmiles

Cashback or Airmiles: A Behavior Economics Analysis

by with 2 Comments Behaviour EconomicsGeneral EconomyMoney ManagementMoney Mindset

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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