Transcript
Paul Winkler: All right. We are back here on The Investor Coaching show, Paul Winkler, along with Ira Work and Evan Barnard. Okay, so, there’s an article: Dogecoin jumps more than 300% as Reddit tries to take on Wall Street. First video game retailer, then struggling movie theater. Now the canine cryptocurrency originally based on a dog meme has seen its value soar.
People Are Easily Led
Over the past two days, it’s ready for users to turn their attention to Doggo-themed digital currency. Apparently this is, this was, it began as a joke as I was talking about. No kidding, no kidding. Elon Musk even tweeted a fake dog named magazine cover, apparently in support of the dog coin. After the digital currency, this guy has been, he’s actually done a few things in the past couple of days and caused Bitcoin to jump significantly just on a single tweet, single tweet. He causes the bit that just shows you crazy. It is one guy, one human, one breathing unit on the face of the planet goes and puts something out there, and this thing jumps in value.
It just shows you how easily led humans are. So speaking of easily led humans, we want to tell there is something that has been a topic of conversation all week long. I got a, I got a text message from Phil Valentine this week. And Phil goes, could you talk about this whole thing with GameStop. Yeah. Could you talk about that?
So it’s a young lady and she is describing all of the, you know what, what’s going on with GameStop. And you know, you’ve been hearing this stuff about the stock surge and blah, blah, blah, and all of that. But I think we’ve got a winner as far as somebody actually giving us some detail on what was really going on.
A Clip
Los Angeles comedian Avalon Penrose explains what’s going on in this funny clip:
“So I had been seeing a lot of people online who were like, what is going on with the stock market? Is there anyone who can explain this in normal person terms? And so I decided I want to do that because like, I own stocks. So I like to have a pretty good idea of the stock market. And from what I understand, there are these people who are, they have lots of money and they have hedges around their house and they go to the market. But it’s like not a real market. It’s a metaphor, it’s metaphorical, but it’s real.
And they go, Oh, that, that company’s not doing well. So I want to, I’m going to make it do worse. So they pull out some papers and they go, who wants, who wants to make a deal? They start making deals. And they say, if this company’s good, if it stays, if it goes down, then I get money from you. And if it goes up, then I’ll give you money. But they don’t tell you that it’s not, it’s not going to go up.
I mean, they will make it so it goes down. But then there was this online reading club that was like, Oh, well not today. We want hedges. And so they took, they went into their bank accounts and then they also went to the market and they were like buy, buy, buy the company and changed it a lot. And so now the initial people give, they have to give their hedges I think to the other people.
So yeah, if you have any questions, just let me know.”
What Is Short Selling?
Paul Winkler: That is hilarious. Online reading club, Reddit online reading club. So, what on earth is going on here? Oh my goodness. This has been the most asked question all week long. So short selling the idea behind short-selling is that you can go borrow somebody’s stock and you go borrow it. And there is a, you can go borrow this stuff. And there are mutual funds, huge mutual fund companies and institutional investors, very common practice to lend shares to people that are short sellers. Now, if we look at the stock market, historically, the market goes up more than it goes down. Three-fourths of the time the stock market goes up and one-quarter of the time it goes down.
So when we look at stocks, we say, well, what’s the risk of selling something based on the idea that you think it’s going to go down to try to make a profit, tremendous risk. There used to be something called an uptick rule. And the uptick rule was basically you, when you borrow those shares and you sell them. So somebody has got a stock that’s selling for $10 a share, let’s say, and you borrow that share, and you can sell it for $10. If you can get it. Now I’ve heard actually. And I think it was one of the big financial networks that made this comment. They said, well, you know, they can actually, when they sell it, they’re going to drive the price of the stock down when they go and sell it.
And then they rebuy it and they can actually make money that way. And they’re manipulating the market. That is not true.
Ira Work: Well, that’s actually the theory behind short sellers.
Paul Winkler: Yeah. But it doesn’t work real well because you got the lower price when you sold it. And when you created that demand for the stock.
Ira Work: Well, if I borrow, let’s say I borrow a thousand shares from you at $10. Yep. And I sell it. I put $10,000 in my pocket.
Paul Winkler: You borrowed it, but you had to sell it. So you had to find a buyer, right? And if you put a lot of supply on the market, you are going to drive the price of that stock down.
Ira Work: Right. And then if I can buy the stock, the thousand shares back at $2, I give you back your thousand shares. And now I have a thousand in my pocket, right? That’s the theoretical.
Paul Winkler: The one that drove the price of that stock down.
Ira Work: Sometimes, I mean, you have to sell millions and millions of shares to drive the prices down.
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Hedge Fund Managers
Paul Winkler: But the problem is that if you borrow it and when you borrow it’s $10 a share. And all of a sudden you say, I am going to get rid of a boatload. You have actually what’s called market impact. And you drive the price down yourself to let’s say $10. Now you’ve got a hope that, that stock doesn’t bounce back up to $10 because of that, that supply is now out of the market. So you’re really taking a huge risk. So if, if that happens, if it goes down to $2, the reason that these people were expecting the game stock was going to go down is for the same reason that people said that blockbuster was, you know, the thing of the past people are not going to want brick and mortar stores to go and buy, get movies anymore.
You know, as we were talking about last hour, they don’t want brick and mortar stores. They want to go and rent the movie on their iPhone or on their smart TV or Netflix. Yeah, exactly. So, basically what’s going on here is there were, there were these hedge fund managers. Now what’s a hedge fund manager? Well, think of a mutual fund company that doesn’t necessarily have all of the restrictions of a mutual fund company. They can go anywhere. They can do anything. They can short sell. They can hold stocks long. They can buy options, contracts, they can put money in cash. They can time the market. They can do whatever they want and they don’t have reporting requirements.
Now some of them do voluntarily report, but here’s the problem is that when you have a hedge fund and there was this belief that these people were just superior managers forever, where did that reputation come from? Well, they manage rich people’s money. And I’m going to be the first to tell you the rich people weren’t necessarily the greatest managers of money. They don’t typically get rich by great management of their money. They get rich because they run businesses. They own companies, and they do things like Bill Gates did, or Warren Buffett, or, you know, Warren buffet would be a guy that was pretty good with investing as well. So I probably shouldn’t use that example, but you know, you have other people that run businesses and they’ve got lots of money, hedge fund managers.
You always hear them as being really rich. Why it’s their business model 2 and 20. They charge 2% when they manage your money and they make 20% of the gains when they do well, they would typically report their results to the public. Hey, we got a record quarter guide for they’ll look at this return on, on this hedge fund. They report and people, Oh, these guys are really good at managing money. If they don’t do well, they don’t report their results. So it would be like a mutual fund manager. If somehow they could only report their numbers. As far as the returns, after a good quarter, he’d be like, wow, I’ve got to have these people manage my money.
So that’s what a hedge fund manager is. These people are all in competition with each other, for them to collude together, to all drive the price of a stock down is pushing it because they’re in competition with; it’s actually illegal for them. Just like mutual foreign companies to collude against one another. Exactly. Not do that. Yeah. Yeah, exactly. Nor would they want to anyway, because their business model would hurt their business model in attracting assets, you know? So yeah. Good point Ira. So if we look at this and we say, okay, so what is really going on? Well, they go and borrow the stock at $10 from somebody. They go and put it up on the market and they sell it.
An Explanation
If they can get as close to $10 as they possibly can, if they drive the price down slightly because of the supply themselves, they come out with all this stock and go, well, shoot, you’re getting rid of all this stock. And I don’t need that much stock. We’ll pay you $10 and maybe we’ll pay $9.50 for it all because you know, we’ll take it all off your hands. And there are institutional fund managers that do this. They will look at a person supplying stock and coming out with a boatload of it and say, you know, wait, I see that you need to get rid of 500 million shares of blah, blah, blah, blah, blah, blah. And guess what, you know, we don’t want to buy that much. We don’t want to, I know man, it’s 500 million.
That’s a lot of shares. Okay. Well, I’m exaggerating to get the idea. We’re getting rid of a boatload of stock and we’re getting rid of a lot more than maybe there’s demand for that stock at a given day when there is a boatload of stock out there to be sold. But there is not that much demand. What will happen is an institutional manager will come in and say, I know you’re trying to get rid of all this, share the shares, tell you what, we’ll take the whole block off your hands, but we won’t pay you the market price.
We won’t pay you $10. We’ll take the whole block off your hands for $9. Now that’s that’s market impact. And that is what big managers will do. And, and, and how they’ll take advantage of the system. That basically what happens here is this. So they get $9. Let me use that as an example, they are hoping and praying that people out there are going, huh? You know what? Doesn’t mean this business model doesn’t make any sense. It’s too much like a blockbuster where it’s old technology and you’re right. We’re going to go online and play games online where we don’t have to go into a store or do anything like that. Yeah. Let’s do that.
And they’re hoping that people will go, Oh yeah, right. This is crazy that we’re paying nine bucks a share for this stock and that it will go down to $5 a share or something like that. Well, they borrowed it, sold it for $9, and repurchased it at $5. That’s what the hedge fund managers are hoping will happen. We’re going to repurchase it at $5. Then they give it back to whoever they borrowed it from. Now, let’s say that there was a 50 cent charge on borrowing the shares, for example. So they sold it at nine, they pay $50, 50 cents for the right to borrow it for a period of time to do all of this thing. And then what they do is they buy it back at $5. So they make $3.50 on each share in this example.
So they’re like, cool, easy money. That’s how it works. There is a tremendous risk. And the hedge fund managers got their heads handed to them because that risk came to fruition in that a bunch of people that were online decided to get together and came up with this idea of buying shares and driving the price up, not down
Ira Work: Well, because they were not professional investors. They were able to collude together, yes. To drive the pressure, to stock up. And then they would buy and hold, buy and hold, driving the precious stock up.
Paul Winkler: And then somebody’s business model kind of got in their way a little bit, which caused all kinds of anger, which Robinhood said, you can’t buy this stock anymore. And that is where a lot of these people did their trading, these non-professional investors, right? And then when they said, you can’t buy this stock anymore, they didn’t have a tool in their tool bag with which to drive the price up further because here’s what happens. They drive the price up to $20, let’s say, and all of a, the short seller goes, Oh no, I’ve got a problem on my hands. I sold the stock.
I netted $8.50 when I did this after my expenses. And now I’ve got to replace that stock from who I borrowed it from now, where do I get the stock to replace it from? I can’t create new stock. I must buy it from those small investors who were hoping that that’s exactly what would happen. Now. Thing is it’s very risky because it was, as I talked to Pamela about, I kind of, it’s kind of gonna be the greater fool theory. In other words, there was somebody up that way and said, well, yeah, I agree. I think that that’s really, here’s the, here’s the greater fool theory. So somebody says, okay, so the hedge fund manager, they sell it for $9.
And then what happens is then the price of the shares goes to somebody who is willing to pay $12 and then somebody else comes out and goes, well, I’m gonna buy some more stock. They buy it for $13 and the next person buys it for $14. Next person buys $15. Next person keeps bidding the price up, bidding the price up. At some point, somebody goes, this is crazy. This is nuts. This stock isn’t worth $30 a share or $40 a share or $400, $350. It was up to $450.
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