Why GameStop Stock Traders Should Beware The 'Law Of Twos And Threes'

GameStop Corp. GME shares closed at $101.74 Friday after the stock surged from under $45 on Wednesday to as high as $184.68 on Thursday.

Some traders may see the extreme volatility in GameStop as chaotic and unbelievable, but former hedge fund manager Whitney Tilson said Friday that GameStop and other meme stocks like AMC Entertainment Holdings Inc AMC and Koss Corporation KOSS have demonstrated textbook dead cat bounces this week.

A dead cat bounce is a large, short-lived recovery in a stock that has experienced an extreme decline. Unfortunately, dead cat bounces tend to be bull traps for traders, tricking some buyers into prematurely believing the bottom is in.

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“Mark my words: These three stocks will never again reach the highs they hit yesterday and will continue their collapses back to their fair values, which are much lower than today's levels,” Tilson wrote in his daily newsletter on Friday morning.

The Law Of Twos And Threes: Tilson said the recent trading action in GameStop, AMC, Koss and other stocks reminds him of a rule of thumb a mentor once called “law of twos and threes.

“What this means, he explained, is that every stock, on its way to zero, doubles three times and triples twice!” Tilson said.

While he doesn’t believe GameStop, AMC and Koss are worth zero, Tilson said they are only worth a fraction of what they are priced at today.

Tilson said the trading action in GameStop and other stocks ultimately results in retail traders losing money and faith in the market, which is bad news for every investor.

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“What's going on sickens me — it's high time that regulators cracked down on all the things that have turned our markets into casinos,” Tilson wrote.

Benzinga’s Take: Love it or hate it, there’s no question the retail short squeeze pump-and-dump strategy has worked like a charm with GameStop.

Successfully timing the entry and exit points in highly volatile short squeezes can be extremely difficult, even for professional traders.