The Madness of Crowds
As a long-term observer of and investor on the “street of dreams,” I’d like to share a lesson in irrational behavior. This week, front page headlines and internet chatrooms were full of articles discussing the trades in several highly speculative stocks, specifically GameStop, AMC Entertainment and Blackberry. Like me, you may have heard of these companies before, but I doubt if anyone could imagine the trading activity that has occurred this week in these three companies. The most unbelievable trading occurred in GameStop. Trading for about $4 per share in September, GameStop closed last year below $20/share. In short order, it vaulted to over $40/share, then closed on successive days at $65, $76, $148, and yesterday at $347 per share. Yes, you read that right.
The front page story in today’s Wall Street Journal captured the dynamics behind this levitation act. Individual investors in chatrooms have been trading against a noted hedge fund manager who had been “caught short,” a phenomenon known as a short squeeze. The idea caught fire on social media. Today, the trading range in GameStop hit gigantic extremes – the highest trade is $483 and the lowest trade was $112.25. Over 45 million shares have traded as of 2:30pm, when I am writing this message. That, my friends, is irrational.
Extraordinary Popular Delusions and the Madness of Crowds is the title of a book written by Charles Mackay, a Scottish journalist. This book was required reading for new advisors when I started in the business in 1985. It was written in 1841, but the lessons are timeless. Reading this book is time well spent.
The Nobel Committee awarded a Literature prize in 1981 to Elias Canetti, a Bulgarian, who wrote a treatise called Crowds and Power. Canetti’s work did not have anything to do with the stock market. Rather, he commented on the human behaviors associated with crowds:
“It is only in a crowd that man can become free of this fear of being touched. That is the only situation in which the fear changes into its opposite. The crowd he needs is the dense crowd, in which body is pressed to body; a crowd, too, whose physical constitution is also dense, or compact, so that he no longer notices who it is that presses against him. As soon as man has surrendered himself to the crowd, he ceases to fear its touch.”
Canetti defined four characteristics of crowds: first, the crowd wants to grow; second, within the crowd there is equality; third, the crowd loves density; and finally, the crowd needs a direction. The individual investors who formed a crowd and began driving up the price of GameStop this week exhibited these traits. And boy, let me tell you they discarded fear in the quest for instant riches.
Investing is very different from trading. One is long term, the other is generally not long term. However, both are part of our capital markets and help in the process of directing capital to better uses. This week, we were reminded of the ability of markets to fall prey to the irrationality of crowd behavior. I hope you will remember this lesson well.
Ralph McDevitt January 28, 2021
Any opinions are those of Ralph McDevitt and not necessarily those of Raymond James.
This market commentary is provided for information purposes only and is not a complete description of the securities, markets, or developments referred to in this material. Any opinions are those of the author and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation to buy, sell or hold a specific security.
