What investors need to know before the next GameStop saga

Finance expert Ted Richards shares 5 lessons from the GameStop saga that can help investors avoid getting burned next time.

GameStop's domination of headlines may seem like old news now, but it caused a lot more people to sit up and take note of the stock market.

The GameStop saga shined a light on the influence that a single subsection of investors (via Reddit or the Internet) can have on the stock market. There are important lessons that both new and experienced investors can learn by reflecting on the rapid chain of events that made the company a household name in late January.

Here are five important lessons that GameStop can teach us:

1. It was another "pump and dump"

The characters within the story might be a little different and so too how it played out, but ultimately this was just another pump and dump of a relatively illiquid stock.

A pump and dump involves the selection of a company (preferably a low-value illiquid stock) and pumping it up as much as you can through rumours and fake news. When the stock price is 'pumped' people 'dump' the shares to someone else.

While this pump was fuelled by a short squeeze rather than rumours, when you zoom out you can see that this is nothing new, and "pump and dumps" do play out from time to time. If you're sourcing stock tips from anonymous accounts within online forums, there's always the chance you could be a victim of the next pump and dump.

2. What the genius does first, the fool does last

No doubt there's a portion of people that made money with the GameStop bubble, but there are also a lot of people that lost a lot. The alluring big performance numbers were too tempting for many to not get involved in the action. Data from Trading View suggests there were around 10,000 individual Australian investors showing interest in trading GameStop in one week alone. Many of these may have jumped in at the worst possible time.

Don't think it's only uneducated new investors that fall victim to alluring high-performance numbers. Sir Isaac Newton, one of the smartest people to have lived, lost a fortune in the South Sea bubble because he couldn't help but get involved when other people around him were making money. Newton ended up losing a fortune on this trade.

3. There's no easy way to get rich quick

After the initial success of the GameStop manoeuvre, many people started thinking this could be a new strategy to make quick money. It may have worked for some this time but the market is pretty smart at adapting to new information. Sophisticated investors have adjusted their portfolios. There's no low-hanging fruit in this space anymore.

There's always a hot new idea out there, be it GameStop, speculative cryptocurrencies, lithium stocks or cannabis stocks. Yes, there will certainly be winners in all of these areas but there's already a large graveyard filled with companies that went nowhere. There's no sure thing.

4. Defence is more important than attack

Warren Buffett once said: "There are two rules when it comes to investing. Rule number 1: Never lose money. Rule number 2: Don't forget rule number 1."

This is critical to remember when investing because positive and negative outcomes have different consequences.

For example, if your $1,000 investment increases by $750 you made 75%. Very impressive! But if the same $1000 investment decreased $750 what returns would you need to get it back to $1000? 75%, right? Wrong… how about 400% before you're just back to square?

There will be people who lost 70%-80% on their GameStop trade. It can take a decade to make that back, which could be catastrophic for their financial situation.

5. Boring is good

As entertaining as it is to watch the events that played out with GameStop, remember that investing isn't about entertainment. Often the best investment can be very boring.

Some other ideas to consider:

• Create a globally diversified portfolio rather than putting all your eggs in one basket;
• Consider ETFs to get exposure to asset classes outside your circle of competence (e.g. emerging markets, infrastructure etc);
• Keep your fees low, as this is one of the few things you can control.
• If you need help, look at options like online investing services that can provide you with resources and insights.

Ted Richards is director of business development at online investment service Six Park and host of investment podcast The Richards Report.

Disclaimer: The views and opinions expressed in this article (which may be subject to change without notice) are solely those of the author and do not necessarily reflect those of Finder and its employees. The information contained in this article is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort. Neither the author nor Finder has taken into account your personal circumstances. You should seek professional advice before making any further decisions based on this information.