The manager of the top-performing hedge fund in 2021 discusses his successful GameStop trade and the lessons learned from it.

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Last year, shares reached a record high of $347.51 on this day, due to a trading frenzy sparked by retail investors sharing stock tips and memes on social media.

Senvest Management's single best trade of all time was GameStop, which yielded $700 million in profit for the firm. This contributed to Senvest's more than 85% returns last year, making it the top performing hedge fund of 2021. While not all professional investors were on the short side of the trade, they still got in on the action.

Richard Mashaal, Founder & CEO of Senvest, spoke with CNBC's Delivering Alpha newsletter about his firm's experience with GameStop and the lessons he learned from it.

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Did you know what would happen before the January 2021 frenzy with GameStop, which you had been invested in for months?

Richard Mashaal: We didn't know what would happen, but we got in in September 2020, which was before the stock caught fire. It's a classic contrarian play for us, and we look for things that are out of favor but have the potential to come back into favor. We saw that kind of setup there.

What is your approach to considering short interest and identifying potential catalysts for a company that has been out of favor, based on the discussions you observed on Reddit forums involving retail investors?

Mashaal: There are a few easy indicators to determine if a stock is out of favor. Firstly, the number of sell and buy recommendations. Wall Street rarely issues sell recommendations, while GameStop had many sells and few buy recommendations. Secondly, the short interest, which was over 100% of the shares outstanding, is a first in our fund's 25-year history. Both of these indicators suggest that GameStop was an unpopular stock. However, the high short interest also meant that it was a battleground stock, which we usually avoid.

Although there were some negative aspects to the situation, we saw management take action to cut costs and adapt to the pandemic's impact on their stores. This led to improvements in e-commerce and helped repair the balance sheet. The company had debt, so they were focused on raising cash. Additionally, the new console cycle was starting, which could drive positive results with higher revenue and lower costs.

Ryan Cohen, the founder of Chewy, had tremendous success in the face of severe competition from Amazon. As a result, there was the thinking that he could affect real positive change and help a transformation story by getting involved in the management or on the board of GameStop.

During that time period, Ryan Cohen was appointed to a board seat and recruited other members to join him. As a result, the stock began to experience significant fluctuations. Can you tell us about your experience working in the offices of Senvest during this period and the decision-making process surrounding whether to hold or sell the stock as it soared?

Ryan Cohen's arrival on the board was a catalyst for further upside in the stock price, as we had short-term and long-term targets for the stock market. While the short-term target was much lower, based on the impact of new console sales and their P&L, we believed that the long-term transformation could lead to a much higher stock price. However, when it comes to a transformation story, credibility is crucial. Ryan Cohen brought that credibility to the table, as he had a proven track record of success. This is why the retail crowd and others jumped on the opportunity.

What were the key indicators that led you to sell during the frenzy, even though you didn't hold on?

We recognized the mania on Reddit and Wall Street Bets, which led us to put aside our fundamental analysis and focus on peak momentum.

Our indicators were different. One of them was a Chamath tweet, which suggested that the thing could go higher. At the time, Chamath was the king of SPACs, and SPACs were hot. People listened to him. We felt it culminated with the Elon Musk tweet on Tuesday afternoon, where he tweeted "Gamestonk!!". Elon Musk is someone people listen to, particularly retail investors, and he has done a transformation himself. He also has a negative view of short sellers. His tweet piled on for us, and we wondered how we could top it in terms of momentum. That signified peak momentum, and we proceeded to exit the rest of our position.

How do you view short selling from a portfolio construction perspective? Specifically, in relation to GameStop, there was a short squeeze element, although the SEC stated that it was not as significant as some believed. Do you currently hedge your portfolio with individual stocks or indexes? What are your thoughts on the current state of short selling?

We are attuned to short interest and avoid heavily barred stocks. We keep our short positions smaller unless they are liquid and have gains on the long side. Short squeezes have always been a risk, especially last year. This year, stock pickers can differentiate themselves on both the long and short sides. The indexes are still close to their highs, presenting opportunities to short overvalued stocks and buy beaten-down stocks trading at their 52-week lows.

Have you learned any lessons from the GameStop incident that you are now applying to your portfolio? You have been in the business for 25 years, but the impact of what we saw last year on Senvest was significant. Do you think you can take away any valuable insights from that experience?

Mashaal: I believe it's crucial to pay attention to the zeitgeist, or the current moment, and understand what's happening. This can have a powerful impact, as seen with GameStop. As fundamental and contrarian value investors, we must listen to narratives and understand what's working in the market. For the past few years, growth and SaaS stocks have been popular, and it was difficult to fight against them. However, now these stocks have taken a hit, and it's important to consider valuation. To stay informed, we can listen to what's happening and read message boards to see what retail traders are saying. It's great to see retail traders coming back, as they were a big part of my career when I started. The financial markets and stock market should not be treated as a game; there's real money involved, and we can learn from our experiences. Young retail investors are engaged and using apps like Robinhood to make investing more accessible. Whether it's stocks or crypto, retail investors are here to stay.