So What’s Up with Gamestop?

What happens when a group of Reddit users band together on a forum and singlehandedly boost the price of a stock of a dying company by 140% in a few hours, and 1,800% in a month? You’re facing the GameStop stock fiasco that ensued in January that left the financial markets scrambling and captivated everyone with the chaos.

Now, if you’re not a finance bro or have zero knowledge regarding finance, you’re probably feeling pretty lost in the jargon of the financial markets, thinking, “How does short-selling work? What the heck is a short squeeze? Is GameStop supposed to be a lemon?”

To break it down, let’s look at what short-selling exactly is.

If you look up the term online, you’ll find an explanation describing it this way:

• An investor, who expects a stock price to fall, borrows shares of that company from another investor for a fee and sells them immediately, hoping that when the price does fall, they can buy the shares back cheaply, return them to the owner and keep the difference.

If that explanation didn’t work for you, think of it in hypothetical terms like this:

• Your friend owns a pair of trendy, zebra-print Nike shoes that’s in pretty high demand right now because of a trending TikTok featuring those shoes. But you know that zebra print is going to fall out of style real soon (because zebra print is ugly), and the price of those shoes will drop in the near future.
• So you hit up your friend and say, “Hey, let me borrow those shoes for a hot second. I promise to give them back to you in two months, along with $50!” Your friend lends them to you and you promptly sell them on eBay for $300. In two months, you hop onto eBay again, and buy those shoes back for $20. You give those zebra-print shoes back to your friend, along with the $50 you promised them. After all that, you’re left with a fat profit of $230 to pocket.

Obviously, this example is a little unrealistic (after all, who’s going to pay $300 for a pair of zebra-print shoes?). But replace the zebra-print shoes with stocks, and now you have a good idea of what short-selling is.

It’s apparent that these kinds of gambles are extremely risky. Going back to the zebra-print shoes: what if the price of those shoes never dropped, or even rose to $400? Then, you have to buy the shoes back (which is called “covering your position”) in order to return them to your friend by the end of the two months, along with the $50 you promised — that’s $150 out of your pocket.

That’s essentially what happened to the hedge funds who took a short position on Gamestop’s stock.

They firmly believed that Gamestop was only going to fall in value, due to their lackluster earnings and declining popularity in the retail space. So if an investor shorted a share of Gamestop at $15, and the stock price reached its peak at $483, they just lost $468. Now imagine that scenario, magnified at thousands of shares, and you’re looking at the mind-boggling losses hedge funds and other institutional investors faced in January. Imagine waking up to that in the morning, and reporting to your boss. Many hedge funds couldn’t even cover the costs, and consequently went out of business.

Now you’re thinking, “How exactly did GameStop rise so much in value in such a short time frame?”

That’s where the Reddit investors slide in: an ambitious soul, dissatisfied with how the hedge funds were helping secure GameStop’s demise by deliberately decreasing the value of the company through their short positions, posted on r/wallstreetbets about how GameStop was extremely undervalued and called his fellow investors to fight back against these hedge funds. Personal investors flocked to this movement, buying as many available stocks of Gamestop as possible, which sent the price soaring and forced the institutional investors who bet against GameStop to cover their positions. This is what is known as a “short squeeze,” which forces the investors who planned to short-sell the stock to repurchase their shares to mitigate any further losses, which would then push the prices even higher.

Now there’s talk about market manipulation, to the extent in which the federal government is involved: The Justice Department is conducting a probe into Gamestop, the Securities Exchange Commission is peering around for shady business, along with the Commodity Futures Trading Commission opening a preliminary investigation.

In addition, we see platforms that “promote” personal investing through their accessible user interfaces, such as Robinhood and WeBull, actually restrict personal investors by banning users from buying new shares of GameStop and other shares of companies (AMC, BlackBerry) trending on r/wallstreetbets.

So how does this relate to you?

Well, it brings into question: is the stock market really a free market, now that we are all aware of how the financial markets can shift with large forces propelling it and how our powers as a personal investor are limited through platforms? What is so fascinating is that this is one of the novel occasions where such a large shift in the market was so public, amplified through social media platforms. However, it’s probably not the first time this has happened. The markets can be moved easily by the heavyweights of Wall Street behind the scenes (large investment firms, high-value individuals with significant influence, or other powerful, enigmatic figures); we can refer back to the stock market crash at the beginning of the pandemic, where there was a mass-selling of stocks from influential figures who had exclusive information about the pandemic that caused the market to crash.

So this poses the question: were the Reddit investors really in the wrong for beating the big dogs of Wall Street at their own game and giving them a taste of their own medicine?

Written by: Emily Jang | IQ Associate