GameStop stock has risen exponentially, but is this risky investment strategy right for you?
The internet has been ablaze as GameStop’s stock price ($GME) has rocketed from $19.95 on January 12, 2021, to a high of $483.00 on January 28, 2021. To make a long story short, this happened because some clever Redditors discovered that 140% of the available shares had been shorted (how this is possible is a story for another day). They realized that by collectively buying up GameStop shares, they could force the short positions to be covered and trigger a short squeeze, making the price of the shares increase even more.
Whether you’re an experienced trader or thinking about trading for the first time, it’s important to consider the risk and volatility of any stock you’re planning to trade. Ready to learn more? We’ll give you some tips on how you can limit your potential of taking a loss, while also considering your potential gains.
What Does It Mean to Short a Stock?
Buying a stock short means you will “borrow” a stock from someone else and sell it now, then repurchase it at (hopefully) a lower price. In other words, by selling first and buying later, you’re betting that the price of the stock will decrease in between your trades.
If, however, the stock prices begin to rise, you’ll want to repurchase your stocks quickly to limit your losses. When this happens, you contribute to increasing the stock price even more, and a short squeeze may be triggered. Because so many people had shorted GameStop’s stock, there was a buying frenzy as everyone tried to repurchase their stocks before prices rose even more—ironically causing the stock to continue to rise.
How to Protect Yourself When Engaging in Risky Trading
While it seems like all fun and games when the price is vaulting upward, there is tremendous risk by investing in a stock that’s going up on hype alone with no financial fundamentals to support the increase in value.
At a certain point, the stock price will peak and people will sell en masse, triggering a sharp decline back down to reality. That leaves many people who bought in late—when the stock price was higher—to take tremendous losses if they don’t get out in time.
However, there are some actions you can take to prevent your potential losses while also giving you the best chances of capturing some of the potential upside. Here are some things you can do:
- Treat your risky trades as if you are in a casino
- Set a stop order on your stocks
- Get out early, even if that means leaving some money on the table
- Hedge your bets
- Buy more than one company’s stock
Treat Your Risky Trades As If You Are In a Casino
Since these risky trades are more like gambling than investing, only trade with money that you’re okay with losing. Resist the temptation to go all in. Avoid trading with any funds you have reserved for budgeting, bills, rent, mortgage, or other essential expenses.
Set a Stop Order on Your Stocks
Stop orders will only sell when the stock drops below a specific price that you set. How high or low you set that number is dependent on the level of risk you’re willing to take, but this will protect you from taking a complete loss on a stock. If you bought the stock at $50 and it’s now $250, you can set a stop order at a number like $200. If the stock drops, your sell order will be triggered as soon as it drops below $200, preserving most of your gains and preventing a loss.
You can continue to adjust the stop order trigger threshold as it moves. You can also set dynamic stop orders on a percentage basis, so that you always put yourself in a position to sell at a price that’s a certain percentage of the highest price after the order is submitted.
Get Out Early, Even If That Means Leaving Some Money On the Table
Market movements are nearly unpredictable for average traders, so think twice before trying to time the market to sell at the exact peak to capture the maximum possible gains. It’s okay to sell earlier than you think you need to, while the stock is on the way up, and realize your gains before things inevitably go awry.
Hedge Your Bet
Hedging your bet means you take multiple positions on a stock, which will decrease your upside and more importantly, decrease your loss potential. This is especially important when trading options or futures. For options, covered calls are a common hedge, and you can read more about them here.
Buy More Than One Company’s Stock
Instead of putting all your eggs into one company, reducing the amount you put in one basket and dividing your total investment among multiple companies will help you mitigate some of your risk. Each company will perform slightly differently, and you’ll likely be able to offset any potential losses from one company with the gains of another.
Investing Is Exciting—But Be Smart
We’re not going to sugarcoat it—investing can be a big risk. Buying up GameStop shares might’ve worked for those clever Redditors, but that doesn’t mean investing will work for everyone. If you’re seriously considering investing, try consulting with a certified financial advisor.