On Jan. 25, the financial world fell into disarray. A group of Reddit users on the forum r/wallstreetbets made headlines when they decided to bet against Melvin Capital. As the Redditors drove up the stock price of GameStop, Melvin lost billions of dollars and was eventually bailed out by Steven Cohen. But the Redditors were not done yet; they proceeded to pump GME the next day, and other stocks such as AMC and Blackberry began to gain their attention. As the shares skyrocketed, the movement spread —young adults and college students began buying the stocks through trading apps, hoping to make a quick buck. Hedge funds lost even more money, and Robinhood stepped in with a ban on trading. You have probably heard about all this. Perhaps you were even one of the many students who considered investing or did invest in the booming meme stocks. My advice? Don’t.
The rise of trading apps like Robinhood has made the stock market more accessible to the average investor and that is undeniably a good thing. If used properly, the stock market has an amazing ability to increase (and even spread) wealth over the long-term. In fact, buying an ETF that follows the S&P 500 and holding it for a period of 10 years would have resulted in a loss during only two decades (1890-1900 and 1930-1940), and would have guaranteed a return on investment for a period over 25 years at any point. Even if you had put your money into stocks right before the Great Depression (1929) you would have made your money back by 1954, and more than doubled it by 1960. Considering the propitious future of American innovation, there is no reason to believe that this growth will stop any time soon.
The problem is that apps like Robinhood are not used for investing; they are used for speculating, or in other words, bourgeoisie gambling. Most of the people who bought GME and AMC did so simply because of the attention, rising prices and peer pressure. But this contradicts every principle of sound investing and can pose a danger for the market. While putting money into stocks when they are going up may seem like a good idea at first, that is not the case. Stocks become more risky as they rise in price, and less risky as they fall. Don’t just take my word for it though. Warren Buffet has made billions of dollars by following this. “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful,” he once wrote in The New York Times. What Buffet alludes to here, particularly in the first half of his statement, is the danger of speculation. By buying stocks that are already overvalued, you are pushing the price even higher, and thus further from the underlying value of the business. This results in a “bubble” which is eventually bound to collapse as stocks return to their normal values. Such speculation notoriously led to the dot-com stock market collapse of 2001 and greatly contributed to the Great Recession of 2008. Most of the people who put their money into speculative assets back then lost everything. Only a lucky few sold before the collapse.
The events that occurred this past week are cause for concern. The same kind of irresponsible buying that preceded 2001 and 2008 is happening again. This time, however, quasi-predatory apps like Robinhood are exacerbating the risk. Whereas large scale speculation used to be mainly isolated within Wall Street, it has now spread to anyone who has access to a phone. What makes trading apps particularly concerning is the lack of regulation that comes with them. While Wall Street’s speculatory endeavors are dangerous, they are at least subject to the government’s laws. It becomes much harder to limit dangerous activities when they come from millions of people spread across social media. This makes market volatility all the more probable, and increases the risks that have traditionally come with buying good investments. Even in the short span of the GME bubble, many value stocks like GM have fallen due to the volatility that accompanied widespread speculation.
“It becomes much harder to limit dangerous activities when they come from millions of people spread across social media.”
Look, I’m not saying that you can’t make money through trading on Robinhood. Just like you can make money by gambling in the casino, you can make money by gambling in the stock market. If you wish to test your luck you can take this route. If, however, you wish to make a safe investment that will bring a fair return, my advice would be to open an IRA (preferably a Roth), put some of your savings into it, buy an ETF, or the stock of a well-established and undervalued company, and hold it. Doing this will require patience, discipline and, if you choose to buy individual stocks, plenty of research. It most certainly will not be as exciting as watching GME go up 120% in a single day. But, in the long run, you won’t regret it.
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I don’t see any plausible explanation or reason why I should just stop using trading apps. And I really keep wondering what I will use instead of them?
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