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If you plan to buy GameStop (NYSE: GME)stock, you are not alone.
Google search “should I buy GameStop stocks” has skyrocketed this week, and the name of the stock has changed several times on Twitter. A combination of massive compression and gamma compression has pushed shares of video game retailers up over 2,000% at times this year, and many other heavily shorted consumer stocks have risen alongside, such as AMC Entertainment, Blackberry, and Express.
In one version of this story, a group of retail traders conversing on social media site Reddit took hedge funds from Wall Street and won. But for other retail investors in other versions, this story won’t end happily.
As exciting as the mania surrounding GameStop may seem, there is a simple reason investors should avoid it and the other stocks that get squashed.
Image source: Getty Images.
A zero-sum game
At its best, the stock market is a vehicle for generational wealth creation, and one that can benefit all participants. While there are always buyers and sellers, everyone can gain if sellers cash in on long-term gains to use those funds for retirement, for example, rather than eating short-term losses.
But at worst, the stock market is a casino, a giant pool of gamblers looking to score fast. Not everyone can win in this case, and it quickly turns into a zero-sum game, with a winner and a loser on every trade. The stakes are only exacerbated with options trading, which has driven much of the activity in GameStop and other cuts.
When stock trading breaks away from fundamentals, as happened with GameStop and AMC, buying them is no different than spinning the roulette wheel. By doing this you are essentially betting that someone will come in and pay more for that stock. This type of speculation – when traders outbid an asset regardless of its fundamental value – is sometimes called the Biggest Madness Theory on the premise that you can flip those stocks to another sucker. This thinking is common in market bubbles.
Understanding loss aversion
Loss aversion is one of the most powerful psychological forces in investing and behavioral economics. According to this theory, developed by psychologists Amos Tversky and Daniel Kahnemann, the pain of losses is twice as powerful on the psyche as the joy of gains. So, as a stock trader, you are going to feel the loss of every dollar lost by betting on a stock like GameStop twice as much (psychologically) as you would feel the joy of making $ 2 in stock value. As volatile as this title is, it’s hard to compensate if things go wrong.
With short term trading and options trading, where greed can easily trigger excessive behavior, I would take this idea further. Even a price gain will not be satisfactory because you will always feel like you could have gotten a bigger gain if you had entered earlier, and this type of approach often leads to greater risk taking and significant and easily avoidable losses in the end. .
By trading in GameStop and AMC now, normal odds setting would suggest you have a 50/50 chance that the price will go up or down, but psychologically the odds are already stacked against you, and the risk of a big financial loss and psychological just is not. Is it worth it.
Sleep peacefully
One of the benefits of long term investing, buying and holding is that there is much less stress involved than in what is essentially day trading. Buying and holding means you don’t have to watch every move in the market. You just need to find quality companies to invest in and stick with them. Take Warren Buffett, one of the greatest equity investors of all time and a man who built a fortune with precisely this philosophy. Buffett advised, “Only buy something that you would be perfectly happy to own if the market closed for 10 years.”
Remember that a stock is a share of ownership in a business, not a ride to the craps table, and businesses don’t double or triple in value overnight – certainly not without relevant news.
Make your life and your mental state easier. Buy top-notch stocks and save the game for the casino.
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