The investment world is abuzz with talk about the ongoing saga involving GameStop (GME -2.88%), Robinhood, and the popular Reddit discussion group WallStreetBets. Shares of GameStop rocketed 400% higher this week as investors triggered a short squeeze in its shares and shares of other formerly out-of-favor stocks.
The drama hardly stopped there, as Robinhood and other brokerages that the retail investors were using to bid the shares higher placed restrictions on trading as the momentum continued.
On the Jan. 28 edition of the Motley Fool Live "Morning Show," Motley Fool's director of small-cap research, Bill Mann, and analysts John Rotonti and analyst Nick Sciple discussed the wild week of trading and provided some valuable advice for investors thinking of jumping into the fray. The brokerage business has changed a lot in recent years, and the GameStop experience provides valuable lessons investors should heed whether or not they own shares of the companies involved.
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John Rotonti: Fools, we said it on the show yesterday, we said it on the show the day before.
Bill Mann: I got it off BeSpoke's Twitter feed, John. [laughs]
Rotonti: You don't want to be short the highest-short-interest stocks right now.
Mann: That's been true since July. It's just even more true right now.
Rotonti: They are targeting the highest-short-interest stocks as a percentage afloat. This is fascinating. We're living through something here. I'm not sure what it is yet, but we're living through it.
Nick Sciple: Part of it is, too, because of the squeeze on some of these short folks, they've had to sell other positions to get a source of funds to be able to cover the shorts.
Rotonti: You see the market down yesterday?
Sciple: Yeah. Exactly. I think there's a lot of people that's like, "Hey, I'm going to rush into these stocks that are ripping." I think the right move, if you are a long-term investor or what have you or once you invest in quality is, PayPal Holdings (PYPL -2.50%) traded down 5% yesterday. I think Match Group (MTCH -2.25%) was down like 5 or 6%, Redfin (RDFN -2.72%) was down 6 or 7%. Some of these companies, that'd be where I'd be looking first is trying to chase some of these stocks.
Mann: Absolutely. About four or five years ago, I was involved in a company called Horsehead Holdings. Do you guys remember Horsehead?
Rotonti: Did it go to zero or close to it?
Mann: It went to zero.
Rotonti: Zero, yeah.
Mann: It got pushed. They had loans that they took out and some of the loans came from nonbank sources, they came from funds. Based on a technicality, the funds pushed Horsehead into bankruptcy. This was a true short attack. It was almost identical to what is happening now with GameStop, but for one big difference, that didn't work out.
Rotonti: Have you all heard of this company Kross? Am I saying this right, Kross?
Mann: Koss (KOSS -1.22%).
Rotonti: Up 2,000% in a week?
Mann: It's a headphones company.
Rotonti: Why not?
Mann: Why not?
Sciple: I'm starting to see a couple of the questions this morning and a lot of these stocks. Robinhood and a bunch of brokerages have shut down the ability to buy these stocks, all you can do is sell them. You have thoughts on that?
Mann: They had to. You know why they stopped yesterday? Because they couldn't keep up with their margin calls. This is a potential disaster for the brokers because a brokerage business is essentially vacuuming up nickels in front of a steam roller when it comes right down to it. There was more volume by dollars on GameStop yesterday than there was on the London Stock Exchange. This is not a little-guy-versus-a-big-guy story, this is little guys have lit a match and the big guys are fighting it out. I don't see how the brokers could not not do something like this because this sort of action puts the brokers' balance sheets at risk. Sorry.
Sciple: It's going to be of interesting. It's particularly from Robinhood's perspective. They just made their core customer base incredibly angry. I would be interested to look at, if you go look at the iTunes or whatever reviews for the app, I bet you they've dropped like 50% of the rating, just today. It's going to be interesting to see what implications there are for them if there's any at all.
Mann: Those aren't their customers though, they pay them zero dollars per trade.
Sciple: Well, that's true Citadel's their customer, right?
Mann: Citadel Capital Management is their customer who pays them so that they can step in front of these people. That's their business. I guess people don't really think when a trade is free, when anything is free that a company is giving you, you are the product. They had to figure out how to survive this and they're getting paid by hedge funds. Let me tell you what yesterday's price action tells me, is that hedge funds were selling down their shorts and they were derisking as quickly as they could with a lot of their longs. This is what a rebalance looks like.
