Generally, when a person buys a stock, the goal is for it to go up in price so it can be sold for a profit. This is typically referred to as being “long” a stock. On the other hand, when an investor “shorts” a stock, the expectation is that the price will go down. A short seller borrows shares of a company, sell at current prices, hoping to rebuy them at lower prices to make a profit. The risk of these trades is not equal. A buyer can only risk its original investment if the stock goes to zero, but a short seller can lose an infinite amount if the price rises dramatically. In this case, short sellers are forced to buy back shares, at higher prices, further exacerbating the buying pressure and ensuing rise in price. This is called a short squeeze. Well, GameStop had more than 100% of the shares borrowed (shares were borrowed from borrowers multiple times over) and the squeeze has been epic, with shares rising from $3 to over $300 per share.
Short Squeezes like this are nothing new, but what is new is the way this occurred. “r/WallsStreetBets”, a Reddit forum known for posting ridiculous “YOLO” trade results of risk fueled massive gains AND embarrassing losses, organized a short squeeze on GameStop, forcing a major hedge fund to lose more money than they even had under management due to these uneven risk parameters. There’s been much discussion over the morality of what took place. Is this market manipulation? Why is it any different than a few hedge fund managers getting together over dinner to discuss and align trades to all profit? Sure, GameStop, a failing video game retailer, is NOT intrinsically worth over $300/share. But isn’t this type of “price discovery”, however ridiculous, what makes free capital markets great? RobinHood and other trading platforms have taken incredible heat from many, including politicians in Washington after restricting people from buying GameStop stock, among other companies. Even if the reason behind this was to protect their investors from the risk involved with chasing heat in a bubble, this seems like market manipulation. After news broke this morning that RobinHood raised additional capital from existing investors, it’s possible they did this to protect themselves. Capitalism can only function properly if markets are truly free and dictating what can be bought, when is anything but that.
Bubbles, and this herd mentality has been around forever. Mark Twain’s quote is often cited in finance, “History never repeats itself, but it often does rhyme”, to point out investor cycles of emotions. We wrote about Kodak and its questionable trading behavior this summer. In 1999 Yahoo! Finance chat forums popped up to artificially pump and later dump stocks. So, this is not historically unusual, but maybe due to our 24/7 news cycle, it’s being more publicized and talked about.
It will certainly be worth watching how this unfolds and how regulation changes, or not, to prevent this type of market movement in the future.
