This determines the next GameStop

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SvD Näringsliv

This column was first published in SvD Näringsliv, in Swedish, on June 14th, 2021.

When the speculators on an online forum decide on a stock, things can move very fast. This week, companies such as Clover Health, Aethlon Medical and Geo Group got to experience what it is like to become a so-called meme stock. But what forces really affect what will be the next Gamestop?

The medical technology company Aethlon has just had a couple of very strange days. It started with the company published a study on the treatment of Covid-19, using one of their products. However, the research was preliminary, and the article had not yet undergone peer review. The whole thing was pretty normal and undramatic. Aethlon’s stock stood still after the announcement.

A couple of days later – when the online forum Reddit drew attention to the company – the stock suddenly soared 465 percent in a single day. Aethlon took advantage of the situation and quickly issued new shares for sale. Suddenly, they had received just over 12 million dollars – at a share price that was almost 300 percent higher than a few days ago.

It’s easy to feel that the stock market – and perhaps the world – is upside down when you read this type of event. But in some cases, there is more behind the big price fluctuations than it first seems. It is therefore interesting to look at what parameters come into play when a share goes from being virtually unknown to becoming a popular meme stock.

Slightly simplified, it can be said that there are two types of investors who invest and speculate in this type of stock. The first group – which we can call the “head” – does their research and presents their thesis like any other stock analyst. They seem to see an opportunity in the market, explain their thoughts publicly on online forums, and let others judge whether it sounds reasonable or not. This is a proportionately small group of people – but all the more influential. A typical example here is Keith Gill, the man who started the Gamestop rally.

The second group – which we call the “tail” – is more opportunistic and speculates mostly based on the reasoning of others. Or for that matter on pure humor – as in the case of the cryptocurrency Dogecoin, which started as a joke.

Buying shares based on someone else’s analysis is in principle no different than following a share tip in a daily newspaper. The big difference is the risk propensity and the scale at which this takes place. This tail of speculators is now so large that they can drive an entire market. Aethlon’s shares were traded 93.1 million times in recent weeks, despite the fact that there are only 827,000 shares available on the market.

The risks are enormous. Was there anything substantial in Aethlon’s new study? Perhaps. But reasonably, not all Reddit speculators can correctly assess this. And even if they are wrong, it may turn out that they are right in the end. The stock price goes up. But not because the study was important, but because everyone buys the share at the same time.

For investors, which we call the “head”, there is a special parameter that provides rocket fuel for share purchases. It is about finding stocks that are very heavily shorted, often by hedge funds. They have thus borrowed and sold shares on the assumption that they will fall in value.

If the share price goes up instead, these hedge funds can have problems, as they have to buy back the share at some point in order to be able to redeem their loans. If the amount of outstanding shares on the market is lower than demand, what is known as a short squeeze can occur – that is, buyers push up the price because they try to buy back the shares again. One of the most well-known examples of this happened in 2008, when Porsche speculated with Volkswagen shares. It was a financial maneuver that cost the hedge funds billions.

If we look at the present, we see clear similarities with both Gamestop and AMC. Both were heavily shorted shares, they managed to get the tail of investors, and then came the big ride in the form of all the shorters who quickly needed to buy back their shares.

So how should one look at the online forum stock pickers – are they risky speculators or geniuses? Both are well represented in the forums. But what they are above all, is dependent on each other. They need insight and they need the scale. If one fails, the other also loses its power.

This column was first published in SvD Näringsliv, in Swedish, on June 14th, 2021.

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