Why GameStop fiasco is not necessarily a gamechanger

The whole world seems to be obsessed with the GameStop (GME) situation, with most people just trying to understand what is going on. I don’t think I have ever received as many market questions from family, friends and acquaintances in a short period of time as I have over the last couple of days. For most of us who follow and invest in markets, it is not what is happening that matters; the more important question I am focused on is what it means for the market.

There are plenty of people saying that this is a major inflection point: a common refrain is that this signifies a democratization of the market from which there is no turning back. I can see why many might think or say that. After all, most of us wish it were true, but it ignores two things.

The first is that this isn’t the first dramatic short squeeze, nor will it be the last. My background is in interbank foreign exchange, and when I worked in a dealing room, position squeezes happened to a lesser or greater degree multiple times every day. They were so common that we never really attached any greater significance to them. It was simply common sense to buy if everyone else was short, or sell if they were long. The bigger the entity you worked for, or the more people you could point that out to and convince to join you, the bigger your chances of success in squeezing out those positions and creating an exaggerated move.

That kind of manipulation and that degree of collusion would probably be illegal now, but to us back then, it was just a legitimate trading technique. So much so that when I left forex and started concentrating on stocks, it completely baffled me why it didn’t happen more often. If anything, the need to borrow a stock to short it made short sellers in the stock market far more vulnerable to pressure than forex traders. Still, there have been a few examples in recent years, with the Dryships saga springing to mind. The GME affair is a dramatic example, for sure, but it is basically just an example of a trade that is as old as trading itself.

The second relevant thing is that this was simply an exceptional situation. The short sellers went too far. Their technique in some cases of shorting, and then publicly trashing companies, had hurt too many small investors who were now looking for revenge. By selling 140% of the issued stock in GME, short sellers left themselves exposed. What the Wall Street Bets community on Reddit realized was that at that level of short interest, hardly anyone has stock to sell. The chances are that if you own GME you had already loaned it out, so you didn’t have it to sell immediately to the buyers.

In other words, there was a shortage of the stock. We all know what happens when short supply meets high demand, right?

Basically, what we are seeing is the collective power of a host of small investors, all of whom have access to significant leverage, harnessing that power. That is enough to create violent gyrations in a small cap stock with exceptional circumstances, and in doing so, punish the over-the-top behavior by short sellers.

But is it anything more than that? Probably not. Here's why.

The fact is that around eighty percent of the total stock available in S&P 500 companies is owned by institutions, and that isn’t counting stock held by company insiders. Even if total unity of individual investors could somehow be achieved, they would still be outnumbered 4:1 if they tried to take on the combined might of banks and other financial institutions in the stock market.

Interestingly, that eighty percent number is significantly lower in Europe and elsewhere outside the U.S., but that is a discussion for another time.

It is not that I want the big banks and institutions to control the market. The reality is that regardless of what happened this week, they still do. Trading and investing based on ideology, hopes, or how you think things should be is never a good idea. Reality always intrudes at some point, and the reality is that the way things stand in America, big money is still big money, and still firmly in control. You may not like that and may believe it needs to change, but there is no sense in denying it, and certainly no sense in going broke trying to prove your point.

To be clear, that doesn’t mean that individual investors can’t make money in the market, or that they will always be ripped off by the big players. It is absolutely quite possible as an individual investor to find good opportunities. Some of those opportunities may even come again when united action meets special circumstances, and they may even be as profitable for some as GME has been this time. But based on my years of experience, they will remain the exception, not the rule.

So no, this isn’t a "turning point" in the way markets work. It isn’t a significant shift in the power dynamic in investing, and it certainly isn’t a sign that small investors should be opposing what Wall Street does at every opportunity. If you try that, you will go broke very quickly, even if you made a small fortune on GME.

By Martin Tillier - NASDAQ.com