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July 30, 2021

Don't bet on the next GameStop, BYU professor advises

SALT LAKE CITY — In the stock market, there are no sure bets. That’s what many learned in the recent Reddit-fueled GameStop bubble that cost short-sellers (and some everyday investors) huge losses, while others won big.

The frenzy introduced a lot of new investors to the market who wanted to be included in the largely unprecedented event. While several made money off of GME, plenty also lost money when the bubble crashed just under $500 per share — far from the internet’s goal of pumping the price to over $1,000.

For BYU School of Accountancy’s Bill Tayler, the phenomenon wasn’t surprising at all considering his research from 13 years ago where he predicted something like this would happen. The research began in response to the stock market’s tech bubble in the early 2000s.

“We wanted to know, well, why would this happen in the real world?” Tayler told KSL.com, “so we took it to a laboratory where we had a bunch of participants come in and trade shares in a single company.”

Researchers wanted to understand why educated investors would not bet against a bubble, even though they knew it would eventually crash like they had seen with the tech bubbles in 2000 and 2001.

The experiment existed in a very simplified market, where participants were told there was a fundamental value of the company, around $500. One trader in the market was a robot trader, which would drive prices up by continuously buying shares. The robot trader represented what’s called a sentiment trader, or someone who is uninformed and buys stock because they like it, not necessarily because they have done the research on why it will do well.

The subjects of the study could do three things, Tayler explained: Do nothing, try to make a profit through short selling the overpriced shares, or buy shares and pump the bubble the robot had created.

In the early rounds, most participants bought shares, knowing the price would continue to increase due to the robot trader; they were trying to buy low to sell high. It caused a short squeeze for the participants who had decided to short sell the stock and buy back at higher prices, which caused the price to skyrocket and create a bubble.

Near the end, participants tried to sell all their shares before the bubble inevitably crashed.

Sound familiar?

“In a market that has sentiment traders that are buying not necessarily because of fundamental value but because of some other belief or purpose, and where short selling exists, you can end up with massive bubbles caused in part by the sentiment trading right and in part by those short squeezes that happen,” Tayler explained.

While the GameStop craze was predictable, Tayler said that doesn’t necessarily mean it will happen again anytime soon. Bubbles in the market, small and large, are common and happen frequently, but it was a perfect storm that led to GameStop’s rise and fall. Not only did social media contribute, but average sellers got in as well, which increased momentum.

One thing that’s important to keep in mind is that research shows the market will learn, Tayler said, pointing out how Redditors attempted to pump other stocks, like AMC, but it never hit the same meteoric rise as GME. And not all hedge funds involved in the GameStop frenzy lost money, Tayler said, noting that many jumped in ahead of the bubble and cashed out before it plummeted.

“We ran that market again and again and again, and we showed that over time the market learns, right? The market participants realize that: one, short selling early was a bad idea because they’re gonna get crushed by margin by a short squeeze; and two, you don’t want to be the last one holding on to those shares,” he explained.

The market has already learned and adapted; some hedge funds were already monitoring social media sites like Reddit, and those that weren’t sure are now, Tayler said.

As for the amateur traders who have gotten into the market recently, either because of the GameStop craze or another reason, Tayler has some advice: Never put money in the stock market you’re not willing to lose.

“Don’t be putting the grocery money in there, don’t be putting your rent money in there,” he said. “If you have some additional funds that (you) can invest, fine.”

Long-term investments, like investing for retirement, are a great financial move for many, and Tayler said individuals with employers offering 401(k)s should take full advantage of it.

For those looking for short-term investing, there are plenty of brokerages to get started with, like Robinhood or E-Trade. Investing can be an educational and positive experience, and potential investors should do research on the companies they are buying into; however, short-term trading comes along with risks, so it’s crucial to stay aware of the market and stay smart about what investments are made.

It’s easy to get wrapped up in the success stories, with some cashing in on GameStop and making millions, but there are also hundreds of other stories not widely publicized where people lost it all after getting drawn into the hype, Tayler said.

“If they’re looking for the next GameStop, I would say don’t hold your breath,” he said. “I don’t think we’re going to see another short-term bubble in a single company, driven by sentiment trade similar to GameStop in the near term, because, again, what happens is people tend to get out earlier and earlier.

“Nobody wants to brag about how much money they lost on GameStop, and so be careful.”

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