Some Wall Street hedge funds suffered big losses last week after amateur trades on Reddit collectively bought shares in GameStop. The American gaming and electronics retailer had been declining, so hedge funds bet against the company using a method called “shorting”. This involves borrowing shares in a company, selling them, and promising to buy them back at a later date. If a company’s value declines, the hedge fund would make a profit – but if the company’s value rises, they make a loss.
Reddit investors bought shares in GameStop to drive its value upwards – meaning when hedge funds were forced to buy back their shares, they suffered huge losses.
The story has been heralded as a victory for amateur investors over the heavyweights of Wall Street, although the value of GameStop declined 58 percent on Tuesday – meaning while some will have made a large sum, those who invested later look set to lose on their trade.
Giles Coghlan, chief currency analyst at HYCM, told Express.co.uk that the GameStop affair is unlikely to be repeated with sustained gains.
He said: “Some people who have lost a lot of money will never recover that – this won’t be repeated, and it’s unwise to take on a hedge fund with its access to data and information.
“I could see flash mobs like this happening again, this could be repeated in isolation, but I can’t see it catching on very much.”
However, Mr Coghlan suggested there is another route for investors to challenge heavyweights in the world’s trading capitals.
He argued that more regulation limiting the amount of leverage retail traders can use will prevent huge losses, ultimately making amateur investors more likely to make profits.
Leveraging is the use of borrowed capital for an investment, expecting the profits made to be greater than the interest.
If investments like this go wrong, traders can potentially lose a large sum of money.
Mr Coghlan said: “What retail investors need to do is manage their risks – hedge funds use leverage very sparingly, but amateur traders use enormous amounts of leverage.
“We need to see government regulation to limit the use of leverage to everyday traders.
“Limit your leverage, don’t trade with borrowed money because you’re amplifying your losses. The ability to make both large gains and losses impairs your trading ability.
“What happens is people get excited, they have large swings in their equity, one of the key things to managing large amounts of money is to reduce your exposure to losses.”
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Last week, Mr Coghlan also offered his advice for those investing in Bitcoin.
He told Express.co.uk: “When you see an asset and think, ‘Wow this can only go one way’ – that is a recipe for either making a fortune or losing a fortune.
“What I’d say is yes, you can invest in cryptocurrencies. I would advise all clients against using heavy leverage and manage their risks.
“Know exactly how much of your capital is at stake at any one time and have a clear exit plan.
“In my line of work you see people do disastrous things if you don’t understand how leverage works, which is the use of borrowed money to take on greater risk.”