Key Points

  • The past two weeks’ roller-coaster ride on GameStop and other heavily-shorted stocks can serve as a valuable lesson to many newly-minted day traders and speculators.

  • But the ongoing democratization of investing is a long road on which we will all continue to travel; though over a few speed bumps along the way.

  • It’s not what you know that will make you a successful investor; it’s what you do.

There is a generic, but common, pair of terms often used to describe individual investors/traders and professional investors/traders: “dumb” and “smart” money, respectively. Given how successful individuals have been during the pandemic bull market—but in particular, with regard to a very unique past few weeks—perhaps the labels should be changed to Davids and Goliaths. Two weeks ago, a tidal wave of retail traders—or Davids—descended on a small subset of the stock market; leaving the smart money—or Goliaths—in a state of shock and awe. It was relatively short-lived though.

Before getting to the meat of that story, let’s first point out that the Davids have done quite well over the past year or so. The chart below shows Goldman Sachs’ index of “retail favorites” (the 50-60 stocks most popular with the retail trading community), which have performed extraordinarily well relative to the S&P 500; especially since last spring.

Retail Favorites Trouncing S&P 500

Get shorty

The last two weeks though was a story of a much smaller subset of stocks than imbedded in the “retail favorites” index above. That subset was heavily-shorted stocks, with the poster child becoming GameStop (ticker: GME). That stock, and to lesser degree a few others, had been aggressively touted on the Reddit subgroup r/wallstreetbets, with millions of subscribers. GameStop—a classic brick-and-mortar, often mall-based retailer selling video games—had been much maligned, given the trend toward all things online and digital. As such, it became a heavily-shorted stock among the hedge fund community. As a refresher, when an investor shorts a stock, it borrows shares at the current price in the hopes of buying them at a lower price in the future.