As the investing world (and the wider populace) continues to focus much of their attention on the GameStop (GME 4.86%) stock-trading frenzy, there's another stock also trading at highly volatile levels: AMC Entertainment (AMC 4.89%).
AMC's share prices have soared close to 300% at various points over the past two weeks as traders in the Reddit social subgroup r/WallStreetBets initiated what is commonly referred to as a "short squeeze." Some who think they missed their chance to take advantage of the GameStop jump are considering investing in AMC because they think there is still some upside to take advantage of.
Here's why that's not such a good idea.
Image source: Getty Images.
What's going on with AMC Entertainment?
AMC's stock situation is similar to GameStop's. Day traders have been investing heavily in the stock, causing its price to increase. As a result, short-sellers who have made transactions involving the stock on the belief that it will drop in value face the real chance of losing significant amounts of money because the share prices continue to rise.
When an investor shorts a stock, that means they are betting the stock price will decrease. They borrow shares from a brokerage and sell them immediately. Then when the stock price drops, they can buy back the shares at a lower price, return them to the lending brokerage, and make a profit on the price difference.
When the stock price increases, short-sellers will eventually need to buy back their shares, especially if the brokerage decides they can no longer borrow the shares. If the price jumps dramatically (like in the case of AMC and GameStop), some short-sellers panic and buy back their shares quickly before they lose too much money. This frenzy to buy back shares actually creates a shortage of available stock to trade and pushes the share prices even higher, even quicker. This results in the aforementioned short squeeze, which really puts a big hurt on the short-sellers and leads to lots of profit potential for those holding the stock.
Why you should avoid AMC Entertainment stock right now
Stocks like AMC and GameStop may look appealing because their shares have soared so high in such a short amount of time. But that volatility is actually a red flag for most investors.
Normally, healthy companies will see slow but consistent increases in share price over time. When any company experiences an extreme stock-price jump, that is often accompanied by some significant news event that justifies the rise. If there is no real corporate news involved, it often means something isn't right. A big jump in price is especially worrisome when it involves a company that has been struggling financially.
AMC Entertainment has taken a major hit to its operations over the past year due to the coronavirus pandemic, and it's only narrowly avoided bankruptcy at the moment. It's likely the company will continue to struggle until the economy returns to at least somewhat normalcy and moviegoers feel safe enough to return to theaters. But even then, AMC will need to show some healthy financials to manage the increased debt it has taken on to remain in operation to this point.
Regardless of whether AMC can overcome its financial struggles, it's still best for most investors to avoid the stock right now. Its price has been manipulated by online traders, and as soon as those traders decide to move on to another stock, AMC share prices will crash. In a scenario like this, it's important to remember one of the golden rules of investing: If it looks too good to be true, it probably is.
