How To Manage Personal Finances Book: Chapter 10: Roaring Kitty and How Stocks Are Traded
Author’s Note:
I am posting a text version of this entire book on Substack, and video versions on YouTube. Email ken@stltest.net for details on my 5th book’s publishing date in late ’24 or early ’25.
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Who is Roaring Kitty?
He’s having his second 15 minutes of fame…
Roaring Kitty is Keith Gill, a popular influencer on Reddit who gained fame by recommending GameStop stock during the meme stock trading frenzy. Dumb Money is a good (not great) movie that dramatizes meme stock trading in recent years.
As of June 12, 2024, CNBC reports that Gill owns 5 million shares of GameStop common stock and a huge position in GameStop stock options. Here’s the stock price of GameStop for 5 days in June of ’24:
You see huge volatility due to people speculating on the price of GameStop. This is a great way to introduce how stocks trade. Ask this question:
“If I sell my GameStop shares, is there a willing buyer? What price will they pay me for my shares?”
Bid price, ask price, and the spread
Let’s say that you own IBM common stock- a publicly traded stock. That means that the securities are registered with the SEC, and that the stock trades on an exchange. Let's assume NASDAQ (an exchange) reports that IBM is trading at around $150 per share.
Stocks trade with a bid and ask price. The bid is what you can currently sell the stock for, and the ask is the price you would pay to buy the stock. The difference between the bid and ask prices is the spread.
The spread can be thought of as the profit earned by anyone making a market in the stock. It’s as if you put the stock in your shop's display window at the ask price (say $150).
If someone brings the stock into your shop and wants to sell it, they would receive the bid price (say $149.50). With improvements in technology, the spread on a large stock like IBM is very small.
The movie ticket line: How a bid price is determined
So, what is stock trading? If you want to sell your IBM stock, you’ll receive the bid price. We’ve experienced periods of huge stock price volatility in recent years, and what that means to you is that the bid price can decline rapidly in a volatile market. That price you receive for your shares may be less (maybe much less) than you anticipated.
Think about a line at a movie theatre. You notice 5 people in line for tickets as you pull up to the theatre. Since the line isn’t long, you decide to park first, rather than let you spouse out to grab a place in line.
After you park and head for the ticket window, there are 20 people in line.
The same thing can happen when you want to sell your stock. With stocks, you have a certain number of people who are willing to buy stock (possibly your stock) at a given price.
Say, for instance, that there are currently 50,000 shares at the $149.50 bid price. Those 50,000 shares are similar to a number of people in line at the movie theatre.
You get the bid price- which could be anything….
Assume that bad news comes out on IBM. Well, those buyers at $149.50 may decide against buying IBM at that price. Say, for instance, that 40,000 of those potential buyers go away. They decide they’d only buy at $145.
You have a market maker who is dealing with buyers and sellers- each of whom may buy or sell a different number of shares. Since 40,000 shares worth of the buyers at $149.50 went away, only 10,000 shares are sold at $149.50. If you weren’t toward the front of line, you won’t receive $149.50- you’ll sell at a lower price.
As more buyers cut the price they are willing to pay for your IBM stock, the bid price declines. Your stock, sadly, is “on sale”.
The GameStop trading risk
GameStop (and other meme) stocks illustrate bid and ask system in the extreme. During the last GameStop trading frenzy, people who put in sell orders had sell trades get executed (orders filled) at prices far below the bid price when the order was placed.
Why?
The stock price declined sharply- and as buying interest evaporated, the bid price crashed.
The Lesson
Less volatile stocks have smaller fluctuations in the bid and ask prices. The sale price you receive or the purchase price you pay may not change much from the current bid and ask prices.
When you place buy or sell orders for volatile stocks, prices can change sharply