Gamestop Takeaway: Taking Risks Can Pay Off, But Find Smarter Risks

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I’ve mostly ignored the Gamestop noise as I didn’t see any actionable takeaways, but then I saw this Reddit post conflating gambling winnings with paying off student loan debt.

This is the same as saying that you bet $10,000 on the Super Bowl, and then used the proceeds to pay off your student loans. The decision didn’t involve much skill, and you got lucky. You get credit for taking the risk, but is that really a newsworthy event?

Consider that if you bet $10,000 on red at a roulette table twice in a row and won both times, you could also turn $10,000 into $40,000. Simple! Every single person reading this has roughly a 1 in 4 chance (22.5%) of achieving the exact same feat (American roulette odds). You just have accept the 3 in 4 chance (77.5%) that you will lose your entire $10,000 and walk away with nothing.

For the most part, these were zero-effort, zero-sum bets. A few clicks, and there is a winner and loser. Last week was not about class warfare, it was just different traders betting against each other. Some average folks won big, others lost big. Some hedge funds lost big, but other hedge funds won big. Nobody “stuck it” to Wall Street! For every Robinhood screenshot that looks like this:

…there is a Robinhood screenshot that looks like this:

My concern is we will continue to see people make easy money (whether in Gamestop or another trade), and others will get sucked into this casino. Like a hot craps table, you want to join in the fun as well. When the market goes up, everyone looks like a skilled trader.

Risk-taking can pay off, but I prefer to search for smarter bets where the upside is huge, but the downside is small. Ones that involve investing a decent amount of time but only a little money. Ones where your personal qualities tilt the odds more in your favor. This is still a risk because you might start a business and fail. You might interview for a promotion and get passed over this time. You might try be a landlord and get a really difficult tenant. You might pursue a specific degree and realize it’s not a good fit. You might ask someone out on a date and get rejected.

In the worst case, you gain valuable experience for later, dust yourself off, and try again. In the best case, you can gain a meaningful life and career (which then leads to financial freedom with a bit of planning). I try to remember that every day we “spend” our time somehow, and it’s a risk because we never get it back. Opening yourself up to the truly big wins is so much better than spending it on gambling (see above), video games, or dead-end jobs. Tell yourself to take good risks.

Here are two WSJ articles about people taking action despite the risks: In the Covid Economy, Laid-Off Employees Become New Entrepreneurs and Is It Insane to Start a Business During Coronavirus? Millions of Americans Don’t Think So. These types of articles are so much more interesting to me than anything about Gamestop.

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  1. As usual you have hit the target dead center.
    Thank you Jonathan

  2. I do think there is an actionable takeaway from Gamestop. There was a kernel of a great idea behind it. And that kernel is: Short selling is as dangerous today, in an era of “easy” mass diversification, as it was in the days of JP Morgan and Cornelius Vanderbilt.

    I used to run a hedge fund. Although I have always been knows for excessive caution (sometimes bordering on paranoia), I lost a lot of sleep knowing that a 100 share short in AT&T had the potential to devastate me. Although this is thought of as an “eight sigma event”—like perhaps the potential for the failure of the Options Clearing Corporation, something that also worried me—we are reminded every few years that these purported eight-sigma events happen a lot more often than they should.

    Anyway, the takeaway is this: Diversification is useful, but it does not cure all ills. More generally, strategies that have excellent statistical parameters are prone to these “black swan” anomalies. So be realistic about the “worst case” in any given strategy, and if you cannot articulate that worst case, invest elsewhere!

    What was this “kernel of a great idea” that I mentioned in paragraph 1? Before the Great Depression, there were many great short squeezes of frightening proportions. With the advent of the ‘33 Act, persons or syndicates amassing a certain amount of stock were subjected to reporting requirements, making squeezes less likely. But in the era of “crowdsourcing,” a huge syndicate is effectively formed with the reporting requirements if the ‘33 Act completely bypassed. This was the beauty of GME. No “wallstreetbets” person, or group of people with any colorable connection to each other, had anywhere near 5% of this company. But collectively, random, unrelated individuals were able to amass a huge amount. This new vulnerability makes *any* strategy involving short selling—including many statistically conservative strategies employed by hedge funds serving top universities and pension funds—much riskier than before.

  3. On a funny note the iPhone user was the winner while the android user was the big loser. Makes total sense …

    Just kidding .

    But really … Thanks for the great insight and reminder that get rich quick is not the way to live life.

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