express– 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.
“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.”
