SCOTT REED: What can we learn from Gamestop?

Mar. 7—I had a request from a reader to weigh in on the recent craziness that happened in trading GameStop stock (GME). For the record, I rarely write about individual stocks. I stopped doing that in the 1990s and I don't intend to start back with any regularity. I think the reader is better served by spending my time on investment philosophy that can be implemented by anyone at any level.

That being said, GameStop is a fascinating issue. This is a company that sells video games in brick and mortar stores. At the end of 2020, one share of GameStop sold for around $18.84. A month later it was selling almost 2500% higher at a price of $483.00. What happened to the stock that would justify that kind of jump in price, you might ask? Nothing. How can you justify that kind of price if nothing has changed at the company, you might inquire? You can't.

It is purely plain stock manipulation, a concept that has been illegal for a long time. When I started in the business in 1985 it was made very clear to me that we were not allowed to take advantage of information we may get before our clients. It is called "front-running." Back then we had access to information that was considered public but, without cell phones, iPads, and laptops, we could get information a bit earlier than other people. We could also place trades in slow trading stocks that would move the price. If I were about to place a trade to buy a stock for a client and I knew it would move the market in that stock, I could buy shares for myself right before I bought them for my client. That would guarantee me a profit ... and a bit of jail time.

Manipulating stocks is similar. Any action that you take to make money off of other investor's ignorance is against the law. Notice that I said ignorance, which is much different than stupidity. Stupidity has always been allowed in the markets, but ignorance is the lack of knowledge that other people are using to move the price of a stock.

There is a problem with this rule. It is often hard to distinguish between the concept of free trade in a free enterprise system and manipulation. In the case of GameStop, a number of institutional investors were "shorting" the stock. Shorting a stock means that you sell the stock even though you don't own it. You hope that the stock goes down in price because eventually you have to buy the stock so you can deliver it to the people you sold it to. If the price drops, you make the difference between your sell price and the purchase price. It is very legal and it very risky.

However, many institutions try to make the stock look bad after they short it so the stock will drop more than it deserves. A group of investors who use social media to communicate decided that they could gather enough buyers together to raise the price of the stock that the institutions were shorting. They were right and the stock skyrocketed. The problem is that you can't collude with others to artificially change the price of a stock, which they did. They will say that there is nothing wrong with talking to other people about what you think. The institutional investors will say they didn't collude because they didn't have a formal plan, but they each know what the other is going to do so they don't need a formal plan.

Scott Reed, CIMA, AIFA, PPC, is CEO of Hardy Reed LLC in Tupelo.