Updated: Apr 30
Thanks for taking the time to read today's blog post. In this series of posts we talk about trade and investment psychology and how to think different from the crowd. Links have been provided for back story and further our readers understanding of how markets work. Please be sure to read the disclaimer on our site before moving forward. Also, subscribe to our blog and follow us on social media (FaceBook, Instagram, or twitter)!
Why does technical analysis do such a great job in understanding markets?
Because after all, it's just human behavior. Even the Large Hedge Fund or Wall Street Firm that created an Algorithm to front run your GameStop trades based off of Robin Hood Data? Yup, that's based off of human design!
I'm sure by now, you're wondering well what the hell does that have to do with GameStop!?!? Human behavior is represented throughout history in variety of ways and if we look back we can see that patterns repeat. That's why we use fibonacci patterns, technical patterns and other tools to determine potential entries and exits into markets. Second, when we look at charts and price we can see when buyers are coming into the stock and when we should be selling - with the help of the noisy media and other market participants.
Before I move forward from here, let me start by saying I wanted to write something at the height of this mania. I had over 4 immediate family members reach out to me, a close friend, and of course my intern, Keegan, and I were talking about it too. One family member even reached out to me saying, "You getting in on this?" (see Figure 1.1 below) and all I could think to myself was, "Oh no, here we go again!" I wanted to do my due diligence and get information from all sides of the story and even stopped into a GameStop for an hour or so speaking with the Manger there who was extremely informative about GameStop and their policies.
Below I have included the text exchange below from my family member (not named), not to vilify them, rather in hopes to see what we can learn from the exchange and I presume what other people on the retail side go through as well. "This is more just a movement rather than making money," and while I'm all for a good movement addressing the issue in this manner doesn't seem like the best course of action to me. I knew after the interview with Chamath on CNBC (I think CNBC should make the full interview available not just to its Pro Customers) and the next day when Robinhood had restricted buying that we were in for a short term top in GameStop.
Why? Remember, human behavior! Patterns repeat. "This is more just a movement rather than about making money." While I agreed with this family member in some regards, it's important to me that our number one jobs as traders and investors is to keep the hard money we've made by removing emotions from the process and staying disciplined. After all what's the point of a movement if the people involved in the movement lose their money and don't learn other important lessons like I have (being patient, and when everyone is yelling, you should be selling). Note: $GME topped the day we had this text exchange and I shorted it the day before (via puts) not to prove a point, I just follow price and let that be my guide.
Should large hedge funds be able to short #Gamestop by more equity than the amount of outstanding shares, probably not. However, there were large institutions, retail traders and others that were taking the other side of that trade making money long before it caught the spotlight. If you think this is the first time this has happened, you are sorely mistaken. This happens time and time again where euphoria is created by a massive buying spree by long equity holders where by the time it reaches the news is when we want to be selling, not buying shares. What may be different this time is the implications that had on the markets as recently told by Chairman Thomas Petereffy of Interactive Brokers stating that "we may have come dangerously close to the collapse of the entire system."
"By the time the news has reached you the money has already been made." I didn't always speak like this or have the knowledge to share this with others. Much like an affair in the Royal Family or news of when a merger is being completed by two companies, when the general public hears about the events in the newspaper the dalliances have been had and the talks have taken place by those two companies before the decision to merge. Ergo the 'smart money', in this case Michael Burry (the trader behind the movie "The Big Short") and the Reddit user, Keith Gill, were well aware of the opportunity trade in GameStop that existed due to the unusual short interest in this equity because hedge funds thought that GameStop would go bankrupt. The interesting thing is when the news became hot in the last week of January, Michael J. Burry had already liquidated his position and Keith Gill kept his massive call option position open (Figure 1.2) that at one point was over $48 million on his original position of $50 thousand. The smart money sold and the retail trader 'hodled'.
"I more of just like the idea of saying fuck the hedge funds!" At some point or another a retail trader will have this emotional reaction and make a really bad decision. This is why in our previous blog posts we have discussed the importance of discipline and managing our emotions. By this time in the GameStop story, Melvin Capital had lost a considerable amount in $GME and need outside sources, Steve A. Cohen's Citadel, to inject cash into it to stay afloat. In a surprising turn of events, Melvin Capital stated on March 17th, 2020 that they were properly funded, and Citadel saw an opportunity to invest in Melvin Capital at a discounted price. There was also an outcry by many, including a well known influencer, Dave Portnoy, on twitter that Citadel was acting maliciously. They stated they actually processed billions of orders during the time.
The damage to these hedge funds is usually caused by themselves taking egregious positions and not properly managing them. Throughout the years there have been several Hedge Funds that have blown up themselves due to large positions that have went against them, so why should we as retail investors and traders worry about what they're doing?! Also, with potential millions of dollars of the line, the Hedge Funds are going to use all the power and influence they have to continue doing what they have been doing.
Price will tell us all we need to know!
So, what was price telling about #GameStop ($GME if you're charting it) on a long term horizon? The relative strength index in $GME created a positive divergence (denoted by the black line where it says "BUY!!" in green in the chart below) on a monthly basis when it failed to stay below its previous all time low in 2003 of $3.75, which is a price we would want to hold if we want to be long against in during the later half of 2020. The black trend line in the chart below shows an inverse head and shoulders pattern where if we want to be more rigorous, we could wait to enter GameStop above $6-$7 as this now gives us a breakout pattern.
Great! So now we are in GameStop based off of our thesis and defined levels of entry as traders and investors, and we want to know when to sell. Should be easy, right!? Well, different investors and traders have different objectives. However, some levels we would be watching on a longer term basis are $17 (prior support becomes resistance) and the $54-$50 area which are all time highs. You can even see that the $17 area held in January and all time highs got taken out very quickly. Thereafter, we hit 5 different Fibonacci levels, of which the 5.618 fibonacci extension ended marking the top in GameStop. So what else helped us know to not get long? When the relative strength index goes from 70 to 98 in one month, it usually means moves like these are unsustainable (the RSI at 98 is marked with a "Sell!!" symbol in red).
So yes, if went long below $50 and were looking to sell based on chart analysis, we could have easily thought to ourselves once everyone in the media was talking about it: "Well I am in below $50, and the relative strength index is telling me this move is not going to last, I should sell." Yes, it really can be that easy! When we don't let our emotions get the best of us, we look at our charts and ignore the noise and can actually make a lot of money with valid decisions. We don't have to be in a large position keeping us up at night not knowing what to do next or worrying if Robinhood won't allow us to buy more, which to me actually seemed like a very good thing to do in hindsight.
From my earlier analysis where we spoke about the Inverse Head and Shoulders pattern that formed on $GME, I included a weekly chart below so that you can actually see what this looks like. Indeed, we can see the different parts of the pattern form that looks like an actual outline of a person. Once we broke out of the neckline (the lower black bar) and confirmed the strength of GameStop via the relative strength index with a potential divergence, (similar to what we saw not he monthly chart) we can get long with a stop below the neckline. Why does price "breakout" from these levels? Because as the stock moves up, institutions have to buy more and anyone short has to start covering creating a 'short squeeze'.
We also broke out of a long term trend line, denoted by the upper long term black trend line, which would allow you to be even more bullish! So what now?? On a short timeframe we can look at going long $GME above $45 if really want to be or if we are already in it and we didn't sell. We've created a really nasty topping pattern so I doubt we'll see $400 again anytime soon. Generally I'd prefer to stay away names like this until they build a nice base of support again. For any updates on the chart be sure to follow for our twitter account: @essex_trading.
I grew up being an avid gamer myself, so I thought if I want a well rounded story I wanted to see what made GameStop special or if there was something I was missing. So I stopped into a GameStop near me other than the one I usually go to to speak with the Manager who was very happy to help with my questions. Perhaps there's something unique that GameStop sells like hard to find videogame dolls or they hold rare cards of Pokemon or YugiOh? Nope!
They are a regular retailer selling video games at retail and discounted prices. They sell merchandise, dolls and playing cards. Some of which are very coveted by avid gamers looking to snap up the latest set of cards or games from Nintendo, Sony, Namaco, etc. These video game developers dictate the price at which this merchandise, cards, and games can be sold with a cap given to all the retailers which are allowed to sell those items. Which begs the question, why don't they develop a system where they are allowed hold on to rare items?
There are certainly some things they could do better: (1) Update their stores so that they are no longer stuck in the 90's - most video games can be bought online so reducing the amount of inventory and cleaning up the layout should be easy, (2) develop a training system that is more customer friendly where quotas are unnecessary - the smooth customer interaction isn't the same at all stores (I was told due to the clientele), and (3) overhaul its digital presence to accommodate its retail presence.
Whatever the outcome of events that unfold for GameStop and their future, I hope that new traders will take this as a step to learn how to correctly trade for the long term.
Essex's Trading Quote of the Day (QotD)
“When they're yellin' you should be selling, and
when they're cryin' you should be buying!"
~Infamous trader adage