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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 are right.
If you're on a trade that has moved 2000% in your favour, why would you want to give back any sizeable portion of those gains? There are at least 2 ways to take advantage of a lucky run that allow you to maintain some exposure while limiting the risk of a large retracement:
taking profit on a portion of your position;
using a trailing stop.
Sadly, most RedditRebels have no conception whatsoever of trade management, position size, or even common sense. And this has cost many of them dearly.
Even if you play short squeezes, you absolutely need to have an exit strategy. Some simple ideas:
a short-term moving average --> sell on a break of the average (this may need to be intraday if the market goes parabolic right away);
a lazy trailing stop below the prior session low --> sell on a breach of the prior session low;
scale out at various stages (so you don't get caught when the market eventually turns, or brokers freeze up).
Also, remember that your entire "trading" capital shouldn't be more than 5% of your savings. This is money that is being put at risk. You may not see it again, despite your best efforts.
Tips from a Professional Short Seller
There is only 1 professional short seller I have seen on the web: Laurent Bernut. I bought his Short-Selling Course a couple of years ago, and I occasionally peek into his Quora feed. There is a lot of wisdom in there if you have the time to dig through all his replies.
Let me highlight some of his insights on short squeezes:
"they are quite difficult to orchestrate but relatively easy to spot:
High borrow utilisation: stocks are heavily shorted. Sentiment is bearish.
Oversold: low RSI is a simple way to see this. Selling pressure must be exhausted so that any marginal buying volume encounters no resistance.
Liquidity: the lower the float or volume, the longer squeezes can go on. Short squeezes in large caps tend be absorbed rapidly".
Mr.Bernut had a program called "squeezebox" he developed back in 2007 based on these principles. If we setup a simple filter on FinViz to find potential short squeezes, here's what it might look like:
Float Short > 30%
RSI Oversold (or at least not overbought)
Average Volume > 500K (to ensure there's decent participation and interest).
As you can see, GameStop is still at the top of the list even though the whole world knows about it now, and as such it's appeal has vanished.
Without going into the fundamentals of the stocks on the list, here are a couple of charts worth watching. If you are familiar with market dynamics, you will know where shorts have placed their stops most likely. The game is to trade into their stops, expecting a nice "pop".
If it doesn't happen, get out quickly. If it does, happy days!
Finally, if you want to find professional data on short interest, check out these 2 sites:
Over to You
Squeezing out shorts is a legitimate trading strategy. But it's not a panacea. It is working very well in the current environment because of the massive liquidity injections and central bank easing.
Basically, anyone shorting stocks right now, independently from the fundamentals, is:
fighting short-term momentum;
fighting the broader bull market;
fighting the specialised army of short-squeeze killers.
It's much easier (safer?) to short a stock that is already underperforming the broader market rather than fade (fight) an established trend.