Is there anything more satisfying than a good David vs Goliath Victory? Last week, a group of around 3 million amateur investors, armed with memes and rocket emojis, managed to pull off a short squeeze against Wall Street and its’ army of Hedge Fund Managers. Reddit’s r/WallStreetBets, banded together to take the stock of GameStop ($GME) in to orbit – from around $40 to a high of $347.51 on the 27th January.
So how does this happen?
Short Selling
Imagine Mr. Short knew that the price of a chocolate bar was going to go from £2 to 50p over the next week. He borrows 100 chocolate bars from Mr. Lender and sells them today for £2 each – he then plans to wait a week and buy them back for 50p to repay Mr. Lender when the debt becomes due.
Hedge Funds borrow stocks from Broker Dealers and sell at the current market price. They then have to buy back the stock at an agreed date to return them. If the stocks have gone down, the Hedge Fund makes money.
Short Squeeze
Now based on supply and demand, the more you sell of something, the lower the price becomes. Mr. Squeeze saw Mr. Short make the deal to borrow the chocolate bar and know they have to give it back in a weeks time. So Mr. Squeeze decides to buy all of the chocolate bars in circulation and wait until Mr. Short has to repay his debts. Once a week passes – Mr. Squeeze is holding all of the chocolate bars and a sign that says, “chocolate bars for sale – £10”. Mr. Short has no option to buy the chocolate bar back for £10.
Reddit saw the price of Gamestop stock going through the floor and wanted in on the action. They bought as much $GME stock as they could afford and held the stock until Wall St. had to repay their debts – causing the stock price to skyrocket, making some users up to $45m.
Stock Manipulation
So if Mr. Short didn’t anticipate the squeeze, how would he guarantee the price of $GME increases? Mr. Short borrows 100 chocolate bars and then goes around telling all of his friends and associates how bad these chocolate bars are. They also tell their friends not to buy any chocolate bar hoping to make the price go as low as possible before they need to buy back their chocolate bars.
In reality, this is illegal, however Wall Street lobbied congress and fought to make 3rd party stock traders, such as RobinHood, unable to sell GameStop stock, in an attempt to make the price of the stock drop through the floor.
The outcome
The Hedge Fund Melvin Capital has lost $7bn on the GameStop stock. With calls for more regulation in the retail investor market space, is this going to ensure that the little man can’t profit from this kind of squeeze in the future?
It’s very difficult to anticipate what this will mean for the future of hobby trading and where the internet and Wall Street will intersect going forward – however, with inflated stock prices, the assets of GameStop could potentially trade above where they “should” be for a considerable amount of time. We could, therefore, see a surge of nostalgic, struggling businesses being “revived” by an army of investors motivated on continuing to give Wall Street the middle finger.