Essay: GameStop Frenzy Shows Greater Need for Safe Trading Practices

Michael Rivera | Wikimedia Commons The recent market frenzy reveals how easy it is for novice investors to lose

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Most of us have heard the legends of Robin Hood, a man who stole money from the rich and gave it to the poor. This folktale of the power of a commoner is truly inspiring but rather rare in modern times. However, we now have our own take on the well-known legend: the popular investing broker called Robinhood.

Appearing to live up to its namesake, Robinhood’s mission is to make investing easier and more approachable for both experienced investors and the general public.

Opening the financial markets to new investors and charging zero commissions is laudable, though Robinhood has made investing a little too easy for inexperienced investors, potentially leading to poor investment choices by novice shareholders. A good example is the famous GameStop frenzy earlier this year.

Two months ago, a popular Reddit forum called WallStreetBets started an investing rally, stirring up a craze to buy typically short-sold stocks, such as GameStop, and almost tripling those stocks’ value in a matter of just a few days. Why was this forum encouraging GameStop? 

GameStop, among other stocks, is frequently short sold by hedge funds to offset their losses. Hedge funds are relatively risky and aggressive financial portfolios in which investors can invest their money.

One of many risky strategies these hedge funds use is called short selling — when a hedge fund manager can borrow stocks and sell them on the secondary market, later purchasing the same amount of that stock back to return it to the pool they borrowed from. 

Hedge funds short sell stocks they believe will depreciate in value, so once they sell the borrowed assets the first time, they can buy those assets back for less, and thus profit from them.

So, when the WallStreetBets investors sent stocks such as GameStop soaring, many hedge funds were losing money since they were forced to buy GameStop at a higher price than what they sold the stocks for. And so, WallStreetBets investors felt an ephemeral rush of control as they shook much of Wall Street.

While many investors felt the thrill of winning big on the stock market, not everyone felt this way.

Many young investors were investing in assets called “call options contracts” — a contract an investor can purchase for a small fee. This lets them buy a stock at the price when the contract was signed, as long as it hasn’t expired. If investors bought an options contract before GameStop prices rose, they could use the contract to buy the stock at a price before it rose and then sell it for higher.

It’s a high profit strategy with incredible risks, and novice investors can lose a lot of money if the conditions aren’t right.

Robinhood allows for investors to options trade directly from their app, making it very easy for less experienced investors to lose serious money in times of market frenzy.

Another concern of the WallStreetBets frenzy was how many novice and inexperienced investors started to jump on the investing bandwagon too late, pouring in many of their savings at a time when the GameStop peak was about to fall. 

For example, the Wall Street Journal reported Salvador Vergara, a young investor, took out $20,000 on a personal loan to invest in GameStop just before the huge drop in GameStop price. Omar, another young investor, told CNN he didn’t sell his options in time when the stocks were rallied up and were falling and lost $22,000 following many of the trends from the WallStreetBets page.

Although Robinhood is a great way to start investing, it makes it too easy for inexperienced investors to enter the markets and make risky trades, especially during crazy market trends like the most recent one.

There’s a greater need to educate the younger generations about safer trading practices that would help set them up for success, instead of letting novice investors loose on an unknown terrain.

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