Melvin Capital shot into the headlines in late January thanks to a tribe of self-proclaimed 'degenerates' and 'misfits'...
These 'degenerates and 'misfits' have now become notorious for their constant memes and toxic forums , but they are also infamous in the financial industry, and will be in the corridors of 535 Madison Avenue - Floor 22, New York, NY 10022...
Melvin Capitals head office.
In this blog we will cover:
A Brief history of Melvin Capital
Melvin Capital is an American investment management firm based in New York City. It was founded in 2014 by Gabriel Plotkin.
They are most famous for the 2021 GameStop short squeeze, where they lost huge amounts of money and the influence that social media has on the financial was first demonstrated to the fullest of its ability.
We will discuss all of this in much more detail later in the article so stay tuned…
What is a Hedge Fund?
The term ‘investment management firm’ is an alternative name for what is essentially a hedge fund, but what are hedge funds?
Hedge funds, in the simplest way possible, are like the hulk of the investing world, they are pooled investment funds which trade with relatively liquid assets to supplement their extensive use of more complex trading, portfolio selection and risk management techniques.
These points must be considered to better their performance. What distinguishes a hedge fund from other funds such as ETF’s and mutual funds are the techniques that they implement.
These include their ability to make use of their wide-ranging ability to leverage, short sell and their use of derivatives.
If you want a detailed description and account of what hedge funds are then make sure to check out this article written by one of our up-and-coming writers at logikfx, Manraj!
Gabe Plotkin: Melvin Capital’s CEO
After graduating from North-western University with a degree in Economics in 2001, Gabriel Plotkin joined the hedge fund Citadel LLC and later Connecticut-based hedge fund North Sound Capital.
Prior to starting Melvin Capital, Plotkin was a trader at SAC Capital where he managed a portfolio of mostly consumer stocks valued at about $1.3 billion. – New York Times
Plotkin founded Melvin capital back in 2014, In a short amount of time he was able to raise around $1 billion in funds.
CIO Gabe Plotkin described the fund to Bloomberg as “a very human-intensive place. We have a lot of analysts; we require a lot out of them”. He also said that the fund has an "intense focus" on the short side (i.e., short selling). This would prove to become key in the coming years.
10 facts about Gabe Plotkin and Melvin Capital:
1. Plotkin Named Melvin Capital after his late Grandfather, who was a small business owner.
2. According to The Wall Street Journal, about one-third of the gains in 2019 from Steve Cohen's current hedge fund, Point72, came from Melvin Capital Management LP.
3. During his time at SAC Capital, Plotkin was the recipient of illegal insider information according to federal prosecutors. Plotkin was allegedly forwarded several emails by Michael Steinberg (a fellow SAC PM) and others that contained insider information.
4. Melvin Capital started out extremely strong in their first year, posting returns of 47%, ranking it 2nd in Bloomberg's 2015 list of top-performing funds with $1 billion or more in assets under management.
5. According to Forbes, Plotkin earned about $300 million in compensation in 2017, making him the 20th highest paid hedge fund manager that year.
6. According to Bloomberg, during 2020 Plotkin earned over $800 million in compensation.
7. During January 2021, he reportedly lost $460 million due to his funds collapsing.
8. Plotkin purchased a minority interest in the NBA franchise the Charlotte Hornets in 2019 from Michael Jordan.
9. Melvin Capital invests primarily in tech and consumer stocks and is reported to have $8 billion in assets under management, as of January 2021.
10. At the end of January 2021, the fund was down 53%, according to The Wall Street Journal. In February, Melvin posted a 22% gain; even with this addition, Melvin will need to produce an additional 75% gain for earlier clients before they break even.
What happened to GameStop in January 2021?
By now if you are still confused as to what happened with GameStop, you must have been living under a very big and lonely rock.
GameStop was the company on seemingly everyone’s lips at the start of 2021 as it experiences both a meteoric rise and fallout due to what investors call a short squeeze
In summary GameStop sell physical discs for video games, a seemingly dying industry in the increasingly digital space of gaming.
January saw its stock price rocket after a Redditt forum r//wallstreetbets got hold of information that among others Melvin Capital had huge, short positions on the company.
Within hours of this news circling the forum hundreds upon thousands of retail investors using the trading app robin hood all bet on the stock increasing in price.
A seemingly impossible feat was achieved over the coming weeks which saw Melvin capital take huge losses and GameStop stock price reach nearly $350.
Shortly after however the stock plummeted back down to previous levels, to find out why read this article by Matty!!
Melvin Capital vs Reddit
As I just mentioned Melvin capital played a pivotal role in the GME sage...
As the largest short position belonged to them, combined with all short positions resulted in more than 139% percent of existing shares of GameStop (GME) being shorted, making GameStop stock the most shorted equity in the world.
By the end of January due to the short squeeze executed by the retail traders of wallstreetbets the fund was down 53% and their clients were not happy!
The short squeeze occurred as huge numbers of reddit traders flooded the market and betting on GME stock to rise.
We know that normally the average retail investor does not trade with enough capital to influence the price of an asset, this is due to that fact that retail traders are just individuals.
In the case of GME though even though Melvin Capital had a big short on GME the retail investors combined capital outweighed Gabe Plotkin’s army of professionals and drove price higher forcing Melvin Capital and its subsidiaries to close or ‘cover’ their positions.
What is a Retail Trader?
So far in this article you would have me mention the word retail trader or retail investor, let me clear this up for you…
A retail investor is defined as a non-professional investor who buys and sells securities or funds that contain a basket of securities such as mutual funds and exchange traded funds (ETFs). – Investopedia
In simple terms Retail Investors are regular people, just like you and me, who enter the financial markets with their own money and trade. Retail traders are not employed to trade and use their own funds and not funds provided to them by an institution.
Retail Investing has boomed recently due to a bigger shift in focus to personal finance and digital investing, thanks in part to the GameStop saga…
Retail investors are normally at a disadvantage when trading though, without the funds and security of a salary from an institution you could say retail investors risk way more that professionals as if they lose out, they could lose a lot of their own savings, while a professional may miss a bonus or get let go with redundancy pay.
It seems like everyone has their own indicators and trading course out there now and its hard for retail traders to get the same information as professionals when it comes to trying to understand the markets.
Professionals benefit from years of training and mentorship from experienced professionals whether the responsibility on retail investors is to find their own strategy and hope it works.
One way That retail investors like the ones in the logikfx forums have found a way round this is by emulating the professional’s methods and strategies and tailoring them to fit the smaller accounts that retail traders run…
If this method of trading interest you make sure to watch, read and listen to the resources listed below to give you a firm idea of how you can get started…
Read up on the strategies used by the professionals: Global Macro Trading - 3 Step Guide for Forex
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How much did Melvin Capital lose in 2021?
There is always a lot of speculation when it comes to this question, this is because e most estimates are just that…
They are estimates.
At the end of January 2021, the fund was down 53%, according to The Wall Street Journal. This would be a huge loss for any investor big or small, to lose just over half of your capital in a matter of weeks is a crushing blow, its something we have never seen before in the Financial Markets.
People with such small accounts, taking on the big guns, and winning!
Why did Melvin Capital lose so much?
As we discussed before Melvin Capital was hugely shorting GME stock, and to be fair to their analysts there is a good reason why their position was so big, the company was losing revenue, staff and stores left, right and centre.
I mean, why would you want to invest in a failing business unless you believed it was going to turn itself around.
As seeing as GameStop had no obvious plans to change their practices it looked like they where doomed to fail.
The retail investors in the reddit forum r//wallstreetbets discovered that GME was very heavily shorted by Melvin capital and many other major institutions, they then gathered with constant posts and encouragement trying to create a buzz around the stock and getting people to bet long on it (buy the stock).
Within a few days we saw millions of retail investors flooding into the market and buying GME stock, catching the institutions off guard.
The self-proclaimed ‘degenerates’ of the r//wallstreetbets forum are now famous for their GME short squeeze.
But why did this work?
And what is a short squeeze?
What is a Short Squeeze?
Short squeezes are all about momentum…
A short squeeze is when a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall, to buy it to forestall even greater losses. Their scramble to buy only adds to the upward pressure on the stock's price. – investopedia
To put it simply when lots of people or institutions are shorting (betting against) a stock and there is a sudden jump in price it causes them to panic and cover (close) their positions meaning that they buy back the asset at a higher price.
Normally to cause a big initial jolt upwards in price like is needed for a short squeeze one or two thing must happen…
1. There must be some positive news related to the asset, either an unexpected rise in revenues or an innovation.
2. A more common occurrence is also that institutions must dump millions upon billions of dollars betting that the stock will rise, and only the biggest of the biggest in the past have been able to execute short squeezes effectively, sometimes they even work together.
In the case of GameStop, the hedge-funds kind of got a taste of their own medicine as the sheer amount of retail traders buying GME actually was enough to drive up price and cause a buying frenzy.
Will Melvin Capital ever recover?
It is more likely than not that Melvin Capital will recover from a disastrous start to 2021, after posting good returns in February it is likely they will recover within 2021 however they will be very much scarred by what has happened.
And now that r//wallstreetbets have claimed a big scalp, the questions on everyone’s lips is who is their next target
While doing the research for this article (especially several very entertaining hours on the r//wallstreetbets forum) I came across a lot of people talking about how great GME was and how great all the other ‘meme stocks’ are and what great investments are.
I think its important for retail investors to know that even though there were weeks where GME looked like it was going to miss the moon and hit Jupiter.
Reality quickly sets in for a lot of people and those without experience in the markets lose a lot of money in the process.
If you want to find a more sustainable and rewarding trading strategy make sure to subscribe and explore all the free content we put out weekly!
Also please discuss your thoughts on the GameStop saga and what you think about the r//wallstreetbets forum!
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