The tables turned on Wall Street on Thursday, 28 January 2021, when a few hedge fund traders in the United States found themselves at the mercy of day-trading Reddit amateurs who have suddenly become one of the most powerful forces in the stock market.
This happened after the stock price of GameStop (GME), a struggling US computer games retail company, soared from US$96.80 to $347.50 in the past three days.
According to The Guardian, a rise of 10,692 percent has been witnessed as compared to its price of $3.25 in April 2020.
The surge nearly bankrupted a few hedge funds to the delight of smaller investors, who invested in accordance with the suggestions of an online Reddit forum, Wallstreetbets.
After the rise in stock prices, several of India's small investors are also trying to snap up shares of GameStop Corp, making it the most traded stock on some Indian brokerages.
Why is everyone talking about GameStop?
GameStop, a US-listed brick and mortar video game retailer company, was not in great financial health, especially after the COVID-19 pandemic. However, the stock witnessed an incredible spike of 10,692 percent from its price of $3.25 in April 2020.
How did this happen?
A group of users on the Reddit forum, r/Wallstreetbets, noticed that the stock of GameStop has been undervalued by the market and is vulnerable to a ‘short squeeze’ (see below).
Therefore, a few users started promoting it and managed to get a few high profile investors such as Ryan Cohen, founder of the online pet food company ‘Chewy’, and Michael Burry, who was among the first to notice the bubble that would lead to the 2008 financial crash (depicted in The Big Short).
The key development, however, was when eagle-eyed observers noted that hedge fund Melvin Capital had been hoovering up a massive ‘short position’ on GameStop stocks (ie, they were essentially betting the stock value would drop drastically, to the extent where they had borrowed more shares in the company than existing ones), which opened up the possibility of a ‘short squeeze’ even further.
Rookie investors on the Reddit forum, with more than 2 million subscribers, encouraged each other to pile onto GameStop’s shares and call options, most of them using retail trading app RobinHood. Share price increased even more after big names like Tesla founder Elon Musk waded in.
What is a ‘short’ squeeze?
On the stock market, you can bet on a share price to fall rather than rise (known as taking a short position). You can ‘borrow’ a stock at the current price, and return it at a later date when the price is lower, pocketing the difference. This is known as closing out a short position.
However, if the stock price increases instead, you run the risk of potentially infinite losses.
In the case of GameStop, after the stock began surging, the hedge funds were forced to buy shares to close out their short positions in the fear of further losses. However, this action further pushed up the share price, creating what is called a short squeeze.
GameStop, before the frenzy, was one of the most sought-after shares on the US market for a short position, as a range of funds betted that it would slump during the pandemic, according to The Guardian.
'It’s Personal’
The only losers in this trade are large hedge funds, and the winners are low-income internet users, some of whom have only invested a few thousand dollars and received life-changing amounts in return.
Beyond the prospect of making money in a tough economy and a hint of schadenfreude, Reddit users say they are punishing hedge funds for their reckless greed that caused the 2008 global financial crisis.
“Your ilk were bailed out and rewarded for terrible and illegal financial decisions that negatively changed the lives of millions,” wrote user u/ssauron on the reddit forum in a post that has 138K upvotes.
“I bought shares a few days ago. I dumped my savings into GME, paid my rent for this month with my credit card, and dumped my rent money into more GME (which for the people here at Wallstreetbets, I would not recommend). And I'm holding. This is personal for me, and millions of others.”
Will this affect any other stock?
According to a report published by The Guardian, this scenario cannot be applied to other stocks that don’t have a significant percentage of short-sellers, or that aren’t down in the dumps.
However, the power of retail traders now seems higher than ever, and social media has been shown to be a remarkably effective method of stock market hype. Similar efforts are being made in US trading to create short squeezes on a number of other companies like cinema chain AMC, on which there were heavy short positions by hedge funds.
Is the White House monitoring GameStop surge?
According to a report published by Fox Business, at the Biden administration’s daily press briefing, White House Press Secretary Jen Psaki told the media that Biden’s ‘economic team, including Secretary Yellen and others, are monitoring the situation’, referring to the GameStop spikes.
What is the latest development in the matter?
Following the rapid rise in the share price, the hedge fund which held the key short position on GameStop shares was on the verge of bankruptcy, but was then bailed out by two other major hedge funds.
The RobinHood trading app also controversially stopped allowing its users (more than half of who owned GameStop stock) to trade in GameStop shares on 28 January, causing outrage over what appeared to be an attempt to save the hedge funds and existing Wall Street status quo, as there was no general block on trading in the shares.
Well-known Democratic Congresswoman Alexandria Ocasio-Cortez called for a hearing into the matter on Twitter, a move which in fact saw bipartisan support from Republican senators and even Donald Trump Jr.
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