'The air could go out of the balloon very quickly.' Lessons from the GameStop investing craze (2024)

It's the stock rally no one quite predicted.

In recent years, GameStop, a video game retailer, has been shrinking its retail presence by closing hundreds of stores. Yet its stock popped dramatically in recent days.

Just last week, GameStop was worth about $40 per share. However, in the past several days the stock price climbed briefly over $500. On Wednesday, GameStop shares jumped more than 130% during trading.

The action was encouraged in part by Tesla CEO Elon Musk, who tweeted "Gamestonk!!" on Tuesday along with a link to a thread posted by investors on Reddit.

The stock's climb was prompted by retail investors who decided to take on hedge fund short sellers who had bet against the company. Shares of AMC Entertainment also jumped more than 300% when markets opened on Wednesday driven by similar bets.

However, the frenzy was curtailed on Thursday after certain brokers placed restrictions on trading, prompting GameStop shares to drop by more than 40% from Wednesday's close. Similarly, AMC shares dropped by about 60%.

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The surge in investor interest has been fueled by several influences: new trading apps and zero commission trading; social media companies like Twitter, TikTok and Reddit; and a corresponding flow of information.

"We've equipped people with the tools to be able to do something," said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York. "And they did."

Feverish interest in a single stock is nothing new. Some experts have said it may be time to brace for a pullback after last year's market surge prompted investors to clamor into names like Tesla or Apple.

But this week's behavior is also unique, namely because of the attention it has been able to attract from retail investors due to the Covid-19 pandemic, said Dan Egan, managing director of behavioral finance and investing at Betterment.

Many people are unable to go to a movie theater, ball game, restaurant or bar, and are feeling isolated due to a lack of social surroundings.

At the same time, social media companies use algorithms designed to keep people engaged by giving certain content more attention.

"I tend to think about these as adding in an accelerant or jet fuel into a normal car engine," Egan said. "All of these things amplify the psychology here in a way that we've not seen before."

The excitement could end just as quickly as it started — and investors need to be prepared.

The quickest way that could happen would be if the Securities and Exchange Commission were to say it was investigating unusual activity such as market manipulation.

As soon as that happens, it could cool everything off, according to Egan.

"The air could go out of the balloon very quickly with a very light regulatory communication," Egan said.

Alternatively, interest could fall off more moderately as the news cycle changes directions and attention on these companies diminishes.

Once vaccines are distributed and people start to return to more normal pre-pandemic routines, this substitute for normal contact will start to go away, Egan predicts.

"It will still be there, it will just be much, much smaller," Egan said.

Admittedly, in order to get big rewards, you have to take big risks.

That is one reason Boneparth said he doesn't discourage his clients from dabbling in individual stocks.

The best time to incorporate those kinds of holdings is after you have done your financial planning, secured your cash flow, identified your goals and aligned your core assets you help you achieve them, he said.

"Once you get through all of that and you've done all of that hard work, it can be okay to take 5%, maybe 10% of your investable assets and go try and find some opportunities," Boneparth said.

Take stock in your personal situation before you risk your own capital in these kinds of bets, advised Sarah Newcomb, director of behavioral science at Morningstar.

If you're new to investing, and don't understand the difference between market price and fundamental value, or you're thinking of risking money you need for your financial security, reconsider, she advised.

"Just like you wouldn't take your rent money to Vegas, don't put your life savings on the line trying to guess what the herd will do next," Newcomb said.

To reduce risk, you may want to try well-diversified funds or large cap stocks that will be less vulnerable to these kinds of market fluctuations, she said.

One way to capture the upside if particular names do well is to invest in broader index funds, Egan said.

"You can just say, 'I want to invest in everything, so if it goes up, I know I've invested in it,'" Egan said. "There are very easy, low-cost ways to do it without causing any stress or really large tax bills at the end of the year."