We don’t get stories like this often…
A Wall Street Goliath just got its butt kicked. But this time our David is a little… well, different.
You’ve probably already seen the headlines. Members of the Reddit forum WallStreetBets have pumped up video-game retailer GameStop’s (GME) stock to ridiculous heights. And in doing so, they crushed a famous short seller.
In other words, a gang of kooky traders blew up what looked like a “sure bet.” And Goliath didn’t see them coming.
Don’t let the reporting frenzy fool you, though. This is more than just a sideshow event.
This is a Melt Up story. And you need to understand it to navigate today’s market.
Let’s get started…
If you feel like the market is getting frothy, it’s not just you. The pandemic-driven narrative of “bored traders stuck at home” is no joke.
In 2019, trading firm Citadel Securities estimated that retail traders accounted for roughly 10% of market activity. By July 2020, that number had jumped to 25%.
This is what it looks like when a Melt Up gets rolling. Retail traders pile in. And they’re not just sitting on index funds.
These traders are moving real money. Trading volume is up over 100% from 2019 levels.
Once you realize this, it isn’t so surprising that a band of kooks took down a Goliath. Retail traders now have the numbers and the power to move the market.
In the case of GameStop, traders went after a highly shorted stock. The company was one of the most highly shorted in the U.S. Famed short seller Andrew Left of Citron Research was vocal about his position. And another highly regarded hedge fund, Melvin Capital, was short as well.
So these kooks went after them, buying the stock in droves. That pushed the price higher and initiated a short squeeze.
That happens when a highly shorted stock rises quickly, forcing the short sellers to cover their positions (which means buying shares)… which causes the stock to rise even more. It’s a painful cycle for anyone betting prices will fall.
The stock closed at $43 a share last Thursday. It’s traded well above $300 a share this week. And this is a company that any rational investor knows has a grim long-term future. It has suffered for years as e-commerce companies like Amazon took over.
GameStop is just the latest example, though. Regular readers may remember that I covered similar retail-investor pile-ins in JC Penney and Hertz Global.
In those instances, traders piled into companies that were about to declare bankruptcy. And in both cases, the stocks jumped up before ultimately collapsing.
Now, it might seem crazy. But this is exactly the kind of behavior you’d expect to see in a Melt Up. These events have all the markings of retail euphoria.
That’s the whole idea of the Melt Up thesis. So don’t let it scare you off.
Instead, remember these key Melt Up characteristics in 2021…
- Retail-trading fervor is to be expected. And it can last longer than you think.
- Volatility is normal. You should expect the market to move erratically. And don’t be surprised by wild swings in retail favorite hot stocks.
- Lastly, corrections are normal too. The Nasdaq fell by roughly 10% five separate times before the ultimate peak of the dot-com boom.
Folks, this is what a Melt Up looks like. All of our data says that the market is primed to keep soaring from here.
From here on out, expect to spot these Melt Up characteristics regularly. And don’t be surprised when a band of kooks pulls off another trading stunt.
These are the conditions we’re living in. It’s time to make the most of them.
Good investing,
— Vic Lederman
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Source: Daily Wealth