This article is the final of a three part series about the recent GameStop saga. You can find the first article, “GameStop and the Short Squeeze” here, and the second on, “Short Selling Is a Vital Trading Activity” here.Today, we are talking about what would have happened if GameStop traders had practiced good risk management.
Every trader claims to follow rules. While some trading rules are sound philosophies and keep you grounded, only one is critical to your success: good risk management. Imagine if those GameStop buyers had not been driven by greed. There would be a lot more millionaires among the Wallstreetbets traders.
Yes, I do know that maintaining discipline when a hot trend appears is exceedingly difficult. The allure of risking capital to gain more wealth is tempting; at times, it’s hard to resist.
As we discussed a few weeks ago, the GameStop saga was a massive short squeeze driven by members of the sub-Reddit Wallstreetbets. They managed to drum up enthusiasm for this very low float (plenty of available shares) stock. Late in 2020 the stock was trading around $4 per share. It was cheap enough for people to buy hundreds, if not thousands, of shares without risking too much capital.
The very poor fundamentals of GameStop were well known, but that did not matter to this crowd. They wanted to make a statement – and did they ever! I read that some who held onto their shares were instant millionaires. That’s great! It’s the American Dream – risk some money and hit the jackpot.
Risk management could have created more GameStop millionaires
When dealt such a strong hand, many traders either freeze or become so overcome with greed that common sense is thrown out the window. Case in point: Missouri Man.
About a month ago, I heard the story of a man from Missouri who followed Wallstreetbets. He bought some shares of GameStop last year, and then purchased some call options.
By the end of January, his account had risen to over $1 million. For someone who only makes $35k per year at his regular job, he was now sitting on a fortune that was 30 times more than his annual income! Quite the haul, wouldn’t you say? On that day, GameStop closed at $320 per share.
When asked by the reporter what he would do, he smirked and said he believed the stock would go to $500, then $1,000. Nope, no need to sell any of it. GameStop would make him even richer than that day. All I could think was, “Why not sell some? Maybe half of it?”
The following Monday, the stock started to crater. After three weeks of intense selling, GameStop is now at a paltry $40 per share. It’s still higher than it was at the start of 2021, but it has fallen hard since January.
Greed is very hard to control. I’m not sure if Missouri Man ever sold GameStop. If he didn’t, I’m sure he learned a valuable lesson: When you take a risk and you get handed a life-changing opportunity, follow your head. Sell! You might not get out at the top, but you’ll be better off in the end.