Putting the squeeze on shorting the market

It has been a year since stores were overrun with panic buys on toilet paper.

I recall a similar story I read about a toilet paper scare in 1973. However, this alarm bell sounded after Harold Froelich, a congressman from Wisconsin, issued a press release stating, “The U.S may face a serious shortage of toilet paper within a few months …” and, “It is a problem that will potentially touch every American.”

Of course, these statements were untrue and used to satisfy his constituency, but the media ran with the claim, and when Johnny Carson cracked a joke on his talk show — it literally hit the fan. Stores were bought out, shelves were emptied and even a black market emerged as people exploited higher prices and a need that should not have existed in the first place.

My thoughts on toilet paper then went back even further to grade school, when my friends and I rode our BMX bikes to the local park. We eventually found our way into the bathroom, where we’d run handfuls of toilet paper under the sink faucet. Once we found the right consistency we’d fire the ball of pulp 20 feet up to the wooden ceiling where it would splat, then petrify and hang like a stalactite for eternity — or at least until the disgruntled maintenance manager would find time to scrape them off.

In retrospect, I realize my mom might not have approved. But one has to remember, at age 10, that “splack” sound took a much higher precedence than a potential shortage, the rainforests and certainly any reprimands. Nonetheless times have changed, and the ceilings are now built much lower.

What does this have to do with financial planning and investment you might ask? Right now, the latest talk has seemingly been the resulting effect of a “short squeeze” with stocks like GameStop, AMC among others. To understand a short squeeze, we have to understand the definition of a short. When investors short a stock, they are basically borrowing shares of stock and selling them at current price.

As these short investors are anticipating the price of that stock to go down, they will then look to repurchase/buy back that stock at a lower share price — thus, gaining the difference in value.

In some cases, these investors looking to short the market, or a particular stock, run into a short squeeze. This scenario exists when investors who believe in the long-term value of a company or investment continue to buy shares to hold for an increase in value. The more investors are buying in for long-term appreciation, the more the price moves higher away from where the short sellers expected a drop in the opposite direction.

Then, much like the squeeze on a roll of Charmin, the pressure placed on short sellers results in them buying shares as they are forced to cover the shares they borrowed. Now this drives the price up even further, and so on as the cycle could repeat.

Now, after taking all that into consideration, it seems in recent months there is a growing mentality that getting rich is a simple few touches and swipes on a smartphone. Rare is the case where you or members of your family will be shorting stocks or trading options, but if so it is important to understand the risks, rewards and consequences of these trades before entering into them.

I present this more or less as an exercise in caution. With the rise in stocks, in addition to the availability of information and trading platforms at our fingertips, it is easy to understand and get swept up into the moment. But as Mr. Breitfelder alluded to in last month’s bizTimes.biz column, wealth and financial independence is typically not something gained overnight.

Guidance from those who have experience in working with different investment strategies and tools can provide a lot of insight as to what is possible. If operating under more of DIY-type mentality, there are a lot of good trading apps and platforms that provide investors with a wealth of information and know-how.

In summary, there always will be greed and fear and with it the fluctuation of markets. There will be times where the vessel will require a little maintenance, but eventually the water always comes back to level. Though the whims and whiffs of a short-squeeze in an online chatroom might make “big-money” headlines, let diligence and research be your core principles and guide your underlying objectives.

Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL Financial or its licensed affiliates. Dupaco Community Credit Union and Dupaco Financial Services are not registered as a broker-dealer or investment adviser. Registered representatives of LPL offer products and services using Dupaco Financial Services, and may also be employees of Dupaco Community Credit Union.