Everyone and their dog is talking about GameStop and AMC. The stock market mania today feels stronger than back in 1999. Back in those days I wasn't yet trading, but my father was. He would go to the local bank's trading room (basically a room with big screen tv sets with CNBC, local news and the FTSE MIB chart) and trade based on his own method.
He would consistently return home frustrated because there were more and more people storming into the room, picking stocks at will or playing the highly leveraged futures on the index...and everyone was making more money than he was.
They had no technique and certainly no common sense given the amounts of money being thrown around. And yet, just like the RedditRebels, they were all making a fortune.
Above is the P&L of the Reddit user who started the whole GME hysteria. This makes him look like the smartest trader around right?
But just 1 day later, here's what happened.
Yes he's still in the money, but he has given back half of what he made. As usual, all the late longs got burned. Anyone that jumped in at $300/share after the market had already gone parabolic was looking for trouble.
Of course, everyone is blaming Robinhood, E-Trade and other brokers for not letting them amass further profits. But there is a reason and it's called collateral requirements.
Without getting into detail, the simple fact is that the NSCC is required to make sure there is always cash to settle. In other words, the NSCC takes on credit risk and demands that firms post a deposit of 10% of the collateral.
However, when firms are leveraged to the limit, changes in the underlying collateral value can lead to immediate demands for more deposits from the brokers. On Thursday, Robinhood had to raise nearly $1 billion in capital to secure the ability to cover collateral requirements.
The risk to the markets is that with brokerage firms already running too lean, even the failure of a firm like Robinhood could generate a ripple effect the size of the Lehman bankruptcy in 2008.
So brokerages had to put the brakes on leveraged trading, and newcomers have learned a lesson or 2.
This phenomenon is a symptom of a mature bull market. When the average Joe is throwing darts or following tips, and makes more money than seasoned professionals, you know we're close to a top.
It happened like this before, and it will happen like this again.
The #1 Rule of Investing
This brings us back to the #1 rule of investing (but it applies to trading just as well):
never invest money without knowing where you are going to sell if you are wrong, and if you