Understanding the technicalities of the GameStop stock story

By now, you've heard about the GameStop stock story. We may not understand all the technicalities of it, but we do get that little investors have banded together to go up against big Wall Street guys to beat them at their own game. 

For a minute, it looked like they were winning. For a week, the markets have been all over the place --but what are the implications for the regular 401k investor? Before we answer that question, let's, first, start at the beginning. 

What exactly is going on with GameStop stock?

It all started when a member of the popular Reddit group, Wall Street Bets, discovered that certain hedge funds were heavily shorting, or betting against certain stocks. One of those was a premier Wall Street hedge fund by the name of Melvin Capital, which started the year with roughly $12.5 billion in assets but was down over 53% for the month of January after having one of the largest short positions of GameStop stock (GME).

All of this happening because the three million members of the Wall Street Bets Reddit group decided they wanted to see if they could make the hedge fund lose money by making the stock to up in what’s called a "short squeeze." 

This strategy began working to perfection as GameStop stock increase from $17.25 to start the year, hitting an all-time high of $483 before recently trending back down. 

For reference, the previous all-time high for GME was around $62 back in 2007. The Reddit group also targeted other failing retailers, such as Bed Bath & Beyond and AMC, which saw similar stock price increases, but not nearly as high as GameStop.

Where is Gamestop now?

Now that you're up to speed on what's been going on, let's look at where we are today.  In the last five days, we've seen the stock soar to an all-time high of $483. But that stock price seems like ages ago since the opening price on Feb. 2 was $227. And it's currently trading at $118 down 45% in one day alone.

It has lost roughly 65% in the last two days. Is anyone still making money? For those that made the wise decision to lock in their profits and sell, they most certainly did.

I spoke with a friend of mine who trades stock options and he sold some call "options" on GameStop stock last Friday, and as early as this past Monday. As long as the stock doesn't reach $800 before the end of this week, he'll profit between $80,000-$100,000. Not a bad week's work. 

There are still many users in the Reddit Wall Street Bets group that are still holding, hoping to see the stock surge higher.

What about all the 401k and stock fund investors? 

Most likely if you have access to a 401k account, then you have seen that your balance increase significantly over the past few days, but all of those profits are most likely already gone. Some of the top 10 shareholders of GameStop stock are not hedge funds like Melvin Capital, I mentioned previously. 

Some of the top 10 shareholders are mutual fund giants that most average investors would be familiar with. This includes Fidelity, Vanguard, BlackRock, and also iShares.

So what are the big lessons? 

I think the first thing is investors need to realize is it's not as easy to make a quick buck in the stock market as one would think. There were thousands of people jumping in trying to buy stock through apps like Robinhood and WeBull thinking that they could turn a small investment and become a millionaire overnight. 

Well, there were certainly many that did profit. Many of those were in for a rude awakening when these online brokers limited trading in these stocks.

Most of those had been watching the stock for quite some time and extensive knowledge in trading in the stock market. With the stocks recent sell off, the normalcy of the market is returning, and people are learning, unfortunately the hard way, what a efficient market is.

Second, is that the price at which you buy a stock matters. If you bought GME at $300 you’re basically guaranteed to lose money if you hold because the company is fundamentally not worth that much. The only reason it’s up there is because hedge funds are forced to buy at any price in a short squeeze. 

Third, investing is a long-term process. You can win or lose on one bet, but performance over the long term as you move towards retirement or financial independence is what matters for most. Diversification, and time work in your favor.

Is it wrong to bet against a company and make a profit? 

There is something that feels sinister to make money by betting against someone else failing. But the reality is those that do this in the way of short selling are actually putting up more risk than somebody that's just buying the stock. 

If you are purchasing a stock, the only amount that you can lose is what you have put in. If you choose to short a stock, you have unlimited loss potential. This is why we saw the hedge fund, Melvin Capital, lose so much in a short amount of time.

Overall, this has been a chaotic and interesting situation to monitor from afar. As technology increases and social media becoming the norm, I suspect that this will not be the last time that we see something like this.

Jeff Rose is a combat veteran, certified financial planner and founder of GoodFinancialCents.com