Rashida
GameStock stocks skyrocketed from $17.25 per share to over $159 on Monday, January 25th, 2021. On Wednesday, it reached $347.51 before it closed.
What on earth made the GameStock shares jump to these never-before-seen values?
A Reddit forum determined to battle with Wall Street investors.
The result?
Hedge fund investors betting short-stocks against GameStock lost A LOT of money.
Oh, and then Robinhood and other stock trading platforms closed the GameStock shares, no longer allowing people to purchase new shares.
How and why the heck did all this happen?
Hold tight.
Terms to Know
Before we can get into all the meat of this craziness, it’s important to lay out a few terms. When I first started trying to figure out what was really going on and why it mattered, I ran into some terms and concepts that made everything way more confusing. If you ever took an econ class maybe you already know this, but just in case:
- Stock: “the capital raised by a business or corporation through the issue and subscription of shares.”
- Share: According to Investopedia, “For all intents and purposes, stocks and shares refer to the same thing.” You need a brokerage account to invest in shares of a company’s stock.
- Hedge fund: A partnership of investors that uses high-risk methods in hopes of making huge capital gains.
- Short-sale: To short a stock, investors borrow shares of a stock they believe will drop. They then quickly sell the stock and can buy it back at a lower price if the stock does drop, making a profit. This is the trickiest concept to understand, but it’s pivotal to understanding what happened. We’ll dive into it in detail shortly.
Understanding Short Sales
Short selling involves borrowing shares for free, and selling them quickly. Hopefully, the stock drops, and if it does, then you can buy them back for a lower price and return them. The end result is that you make money, and you won’t even have to return them if the company goes bankrupt.
If you were a bit confused by that explanation of a short sale, I don’t blame you. It still doesn’t make a ton of sense, but it’s a very lucrative way to make money for hedge funds.
The thing with short selling is that you could lose money if the stock goes up. On the contrary, losses are potentially infinite if the stock continues to increase, and you may end up owing more fees or having to buy the stock back at a higher price to cover.
Why Hedge Funds Were Short-Selling GameStop
Hedge funds look to short-sell from stocks they believe will fall. Oftentimes, this means going after companies that are on the decline. GameStop was founded a year before Blockbuster, and is basically a consignment shop for video game items. You can trade in old games, consoles, and accessories for money or store credit that you can use to buy gently used equipment.
The problem is that GameStop’s business model is becoming outdated, especially in light of COVID. Many games are sold directly on consoles. Even if someone did plan to buy or sell a console, chances are they’d head to Facebook Marketplace, eBay, or Amazon first.
So, really it makes sense to think GameStop is on the decline, and their stocks reflected that. Therefore, GameStop was the perfect option for short-sellers. Basically, short-selling is a way to profit off of companies that are failing, losing stock, and heading for bankruptcy.
Hedge funds were betting against GameStop, with more people short-selling than purchasing shares. Short interest was 71.2 million shares, while there were only 69.7 million shares outstanding.
The sheer number of shorts created the perfect environment for a chain reaction…
Robinhood and Internet Stock Trading
Previously, only professional traders could purchase stocks and options, but now the process is accessible to anyone. Trading apps like Robinhood make it easy to buy stock options. It removes many of the barriers of entry, and it’s become a popular place for amateur investors to dip their toes in the process.
r/WallStreetBets
r/WallStreetBets is a forum on Reddit. Throughout quarantine, interest in investing has gone up and many internet traders head to Reddit to discuss the topic. Recently, they decided that GameStop was undervalued and decided to invest in its shares.
The Reddit stock trading chat community began buying GameStop shares to create demand. The Reddit r/WallStreetBets community orchestrated a “short squeeze” by buying a ton of shares in GameStop, which drove up the price. The group started this back in October of 2020, but this past week is when things have gone absolutely crazy.
The Effects of the Short Squeeze
As GameStop shares hit numbers higher than ever before, the story gained interest and buzz, which further surged interest and investments from those on board with r/WallStreetBets. The phenomenon is not limited to GameStop, as the groups have also begun implementing similar tactics for AMC, Bed Bath and Beyond, and other commonly shorted stock.
The result has been enormous losses for the hedge funds that were shorting GameStop. According to Investopedia, shorts betting against GameStop lost about $5 billion, with almost half occurring on Friday when stocks jumped by over 50%.
Remember, the short-sellers bankes on GameStop losing. Since the stocks started gaining, it created big trouble. The short seller has to return the borrowed stock to the lender, but they have to buy them back at a higher price instead of a lower price. Instead of gaining money, they lose money. The more the shares gained sense the short seller borrowed the stock, the more they lose.
The Response
Trading apps like Robinhood responded by restricting the trades of some stocks during the crazy fluctuations. For doing so, they’ve fallen under intense scrutiny from Reddit users and politicians, with many threatening a class-action lawsuit against the app. People are especially angry at Robinhood because they claim to be working in the best interests of users, but fail to provide clear evidence of that.
Nasdaq’s policy is to halt stock trading if it discovers a link to suspicious social media activity. It wants to ensure the markets act legitimately.
Oh, and Tesla
Elon Musk was also involved in the ordeal. With his 43 million Twitter follows, Elon has discovered he can drive up companies’ stocks. Using his typical odd language, Musk tweeting about GameStop and drove the frenzy.
What on Earth is Next?!
If this sounds absolutely crazy, just know that it is. Along with the head-spinning logistics, the GameStop stock madness has stirred up immense controversy, misinformation, and general confusion about the stock market.
There are so many different directions things could go from here. How will the market recover? Will Redditors file the class action lawsuit against Robinhood?
As we’re still in the midst of this wild stock market saga, there’s a lot left to be seen.
