It is really helpful as an investor to know your position on the food chain.
Are you a whale, shark, salmon, minnow, or plankton?
Here is a hint: If you trade on Robinhood (or in Canada, Wealthsimple) exclusively, then you are plankton.
Why is that?
Before I explain, let’s recap what has happened so far this week (VERY BRIEFLY):
- A number of large hedge funds (Melvin Capital and Citron) take stupidly large naked short positions in Gamestop (GME-NYSE) and don’t use any derivatives to offset risk
- Retail investors on the social media platform subreddit wallstreetbets notice this and start accumulating the stock, causing a short squeeze.
- Hedge funds are now billions in the red and are forced to close out positions. But other large players are still short and start to complain to the old boys’ network.
- Trading platforms like Robinhood no longer take buy orders for Gamestop but do allow their customers to sell. And that stinks because it looks like the Wall Street elite are screwing over retail.
- Gamestop dumps 44% today.
Is Gamestop going bankrupt and the stock is going to zero?
No, not anytime soon. Here is an excellent take on the Gamestop situation here. The more you read that link, the more you scratch your head and think: What were these hedge fund guys thinking?
And the answer, they were not thinking at all. They were either a) Lazy and arrogant or b) Not that smart.
In either case, no surprise they got their heads handed to them on a platter.
But of course, that leads to the question, who was buying Gamestop on the day when Robinhood traders were forced to hold (or sell)?
The answer may surprise you. Guys like me. And I am no whale or shark.
(I didn’t buy Gamestop today. But I could have. And just for giggles, I may buy it tomorrow.)
I can buy Gamestop because I have a full-service brokerage account. A quick phone call to my broker today confirmed that yes, Gamestop stock is available for sale for anybody who is not a Robinhood trader.
The average retail investor should understand the food chain and where he or she sits on the food chain.
From the bottom up:
- Robinhood and any of those crappy trading apps where trading fees are zero. (Plankton)
- Discount brokerages that charge a flat fee like $4.99 or $9.99 a trade. (Minnow)
- Full-service brokerages where a commission is charged on a trade. Think hundreds of dollars or thousands if the trade is big enough. (Salmon)
- Full-service brokerage where your broker is a rainmaker giving you access to hot deals (More on that later but salmon and sharks live here).
Note that position on the food chain is not based on how much money you have, or how much you trade but on access.
For example, a dentist who is swinging five-figure trades on Wealthsimple in Canada is still plankton, even if she or she goes home in a BMW every day.
A peasant platform like Robinhood or Wealthsimple gives you peasant access, as many retail investors found out today. And access is granted or denied according to the whims of the gatekeepers.
Discount brokers are better than Robinhood, but that’s not saying much.
And that brings me to full service brokers. With their humungous fees, why do they still exist?
Access, my dear reader, access.
Ever heard of private placements? Do you know what the difference is between an accredited investor and a retail investor?
An accredited investor is one who has enough liquid assets (or can show enough income) so that he or she can sign a bunch of documents that essentially say they are sophisticated to buy into risky stock and can afford to lose money.
What does that mean?
It means you get to buy stock wholesale and sell it at retail.
That is what a private placement sale is all about. A company, through a brokerage house, will sell a large block of stock, almost always below market price, to accredited investors, who then agree to hold the stock for a certain period of time (usually four months).
Then after the waiting period is over, you can sell the stock on the market I.e. retail, at (hopefully) a nice mark-up.
That’s level number three on the investor food chain.
Level number four access is getting the right broker. If you want to hook up with the rainmaker of whatever brokerage house you are patronizing, then there are a couple more hoops you need to jump through, as well as having accreditation.
- A willingness to pay fat trading fees, over and over again.
- A willingness to hold onto stock for a reasonable period of time i.e. don’t dump the stock the first day you can.
- A pleasant personality.
I’m not kidding about #3. The rainmakers ALWAYS have more money thrown at them than they know what to do with. The best deals are always over-subscribed. That means they don’t have to deal with people who are unpleasant to talk with.
Think about that next time you are on the phone complaining to your broker about the $3k you dropped on a penny stock that just got de-listed.
If you get to level four, congratulations, you are officially a salmon (or bass, if you are in the US). You get to swim with the sharks, who may take a bite out of you if you are not careful, but really, it’s easier for them to go after minnows.
And you should never get gulped up by the whales.
Now, if you are still thinking should I be buying or selling Gamestop, you are missing the point of this article.
Climb far enough up the golden staircase and you would see it’s not question of buying OR selling, but doing both, and profiting either way.
HEDGE funds are called that for reason. If you are really hedging, then it should not matter if the stock goes up or down.
You can short the stock and buy calls to cover, or sell covered calls, or something, anything other than going naked as these guys did.
In my opinion, a naked short is a sign of a degenerate gambler. Whether you are a retail investor with only $1000 in your pocket, or a billion-dollar hedgefund player, don’t ever do that.
Doesn’t matter anymore for those guys that Robinhood is trying to come to the rescue and ball them out
In this business, once you are shown to be that foolish, you are as good as dead. Bye-bye Melvin Capital and Citron.