Dimensional's Approach to the GameStop Trading Events

“You can’t invest without trading, but you can trade without investing. … [T]hinking you’re investing when all you’re doing is trading is like trying to run a marathon by doing 26 one-mile sprints right after the other.” — Jason Zweig

 Are you out of breath trying to keep up with the recent news about GameStop and all the other red-hot trades of the day? To briefly recap, during the last week of January, a perfect storm of traders converged on the market, propelling the prices of a few previously sleepy stocks into the stratosphere. Jason Zweig of The Wall Street Journal reported, “From Jan. 25 through Jan. 29, a ragtag army of individuals sent shares in GameStop Corp. up 500%, and sent many others skyrocketing too.”

 Interestingly, there was no huge, breaking news or major shift in these companies’ fundamentals to explain the surge. Instead, a tidal wave of trading momentum happened to form on a Reddit forum called WallStreetBets.

If the GameStop movement had a leader – or at least a cheerleader – it might have been Keith Gill, aka Deep F***ingValue, who had been entertaining his online friends with GameStock status reports since he began trading it in spring 1999. The Wall Street Journal reported, “Mr. Gill said he wasn’t a rabble-rouser.” But, the report continued, “Many online investors say his advocacy helped turn them into a force powerful enough to cause big losses for established hedge funds.”

Whatever inspired the movement, it soon became a force of its own, like an online flash mob buying and holding shares at increasingly higher prices. Why would anyone do this? Some may have just gotten caught up in the excitement. Even Elon Musk got in on the action with his Gamestonk!!” WallStreetBets tweet. Others were hoping to profit on a communal squeeze play against “fat cat” hedge funds and others who had chosen to short-sell the same stocks.
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When a trader short-sells a stock, they’re betting the price is about to drop. If it does, they can profit handsomely. But if the price instead shoots upward, a short-seller can face a margin call, requiring them to cough up the difference between the original share value and the fast-soaring price. In the case of GameStop, short-sellers like Melvin Capital Management lost billions of dollars meeting margin calls, which in turn became chum to the feeding frenzy.  

 As the frenzy continued, many retail trading platforms – including Robinhood, Schwab, TD Ameritrade, and others – started experiencing trading overloads. Technical glitches as well as deliberate trading restrictions ensued. Not surprisingly, traders impacted by the lapses and restrictions have cried foul, perhaps rightfully so.

Is the phenomenon just a new, but legal variation on a very old market mania theme? Did anyone actually violate existing regulations, and if so, whom? Are new regulations warranted? Securities regulators are considering these questions, not yet resolved.

Dimensional’s Approach

AMDG Financial designs client portfolios using mutual funds and ETFs from Dimensional Fund Advisors, and when the GameStop story first broke, we received some calls and emails from clients asking how the short squeeze might affect their investments. Last week, Dimensional explained how it handled GameStop in a timely and interesting article that demonstrates why DFA’s approach works so well for our clients.

Dimensional is very clear about its investment process, which it designed to take abrupt changes in stock prices in stride. It constructs portfolios by overweighting (also called “tilting”) toward securities that have higher-than-expected future returns. Historical data shows that in both the U.S. and international markets, value stocks and small-cap stocks have produced significantly higher returns than broad market indexes over time.

Before the short squeeze on GameStop’s stock, Dimensional had included it in its small-cap portfolio. But when the trading frenzy drove GameStop’s stock price and market cap above a certain threshold, it no longer fit Dimensional’s criteria for the small-cap asset class. Because of its daily evaluation process, Dimensional was able to act quickly to manage its holdings. And, when the price of GameStop stock ultimately fell back into the small-cap realm, Dimensional determined that its low profitability growth made it a poor candidate to remain in its portfolios. As the article mentions, Dimensional ultimately sold all its interests in GameStop by Feb. 3.  

Why a Patient, Consistent Approach Matters

Over time and around the globe, winning and losing traders converge, and create market growth. Their volatile trading games translate into long-term market returns. As an investor, you can capture these returns by buying and patiently holding broad market positions, based on your willingness, ability and need to take on investment risks in exchange for expected market returns.

For investors like you, it really is that simple, and we’re here to help you do just that. If anything, these recent adventures in trading land should underscore (with a thick, black line!) how impossible it is to predict where any given stock, sector, or forecast is headed next. All the more reason to bet on the efficiency of a long-term, globally diversified portfolio, and to leave the GameStop gambles to the traders.

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