GameStop has been making headlines this week. The stock whose value has increased drastically; not because of the company fundamentals but because of speculation fueled by a Reddit Community. Let’s dive into the story of GameStop.
A group of traders from a Reddit Community called WallStreetBets battled with billion-dollar hedge funds to skyrocket the price of GameStop shares, a struggling video game retailer company, to an all-time high of $483, a 2560% increase since the beginning of the year.
WallStreetBets referred to as “r/wallstreetbets” is a discussion forum on Reddit. Jaime Rogozinski founded the group with the intent of providing capital to society on January 31, 2012.
The discussion group often talks about speculative investing. The users are mostly teens and millennials frustrated with the current financial system and looking for a way out of the old traditional school of index investing where the returns are meager. On various occasions, they have found and exploited key weaknesses in Wall Street or financial products and profited from it.
At first glance, the forum appears to resemble a chat room from Xbox Live or PlayStation Plus. Reddit being the commonplace of discussion, the platform uses foul language and memes to discuss investing. The active users call themselves “autists” (autistic people) or “degenerates”.
Little by little, it has turned into a casino, a place for speculative games. The group caters to those individuals who live with a “YOLO” attitude (You Only Live Once) and approaches trading and gambling in the same way.
The discussion forum reached its first million subscribers in March 2020, after eight years of its existence. But in January 2021, with the GameStop incident, subscribers increased exponentially and now have a subscriber base of 8.5 million.
Before we move further, let’s discuss short-selling because that is where it all started.
Short-selling is when an investor sells borrowed shares with the hope of buying the shares back later at a lower price, hence profiting from it. This method is called short-selling, and it’s completely legal. It is the opposite of traditional investing where profit is earned from the increase in stock’s price. In short-selling, if the price of a company’s stock falls, then only the traders make money. And if the opposite happens, the losses can be substantial since the traders need to cover their positions by buying the shares back at a higher price.
Many institutional investors keep looking for an opportunity to book profits by betting against the company’s share price i.e., short-selling. In GameStop’s case, billion-dollar hedge funds like Melvin Capital, Point72, Citron Capital, D1 Capital, Maplelane Capital, and Candlestick Capital Management had been short-selling the shares without being noticed. But then, amateur traders from Reddit forum “WallStreetBets” decided to act in unison and started buying GameStop shares, initially because they thought it was undervalued, and then to send a message to the short-sellers. This event pushed the share prices up to astronomical levels causing massive losses for short-sellers i.e., the hedge funds.
This GameStop event demonstrates how immensely profitable and enormously risky short-selling can be.
The GameStop story started when short-sellers started losing confidence in the company’s future since the company was facing a lot of challenges due to the pandemic. Last year, GameStop’s share hit a low of $2.57. After that its price started rising after a well-known hedge fund decided to back the company, and on 31st December 2020, it closed at $18.84.
Things were going normal until amateur investors from “WallStreetBets” entered the battleground, and several Reddit users called for people to pile money into GameStop shares, pushing up the price to put pressure on the short-sellers – a process known as a short squeeze.
For them, it was an act of punishing the hedge funds who were earning profits from the company’s troubles, and for some, it was an opportunity to make money. According to data from various financial analytics firms, short-sellers have lost an estimated $6 billion on GameStop shares.
Short-sellers are required to buy the shares back as they are obligated to return the borrowed shares to their rightful owners. When short-selling shares, traders need to deposit a “margin”, which is a safety net to cover their losses in case prices of the shares rise up. If the margin deposited becomes insufficient due to rising prices, a “margin call”, or a demand for more margin is made to the traders in case they want to maintain their short position on the stock.
In the case of GameStop, the Reddit users acted together to artificially push the price of the shares up, which triggered the margin call for the hedge funds. These hedge funds started facing huge losses and hence had to square off their short position by buying the shares at a higher price, which created an artificial demand for millions of shares and hence pushed prices up further. This was the short-squeeze method which the Reddit users took to inflate the share price of GameStop by 2420% in merely two weeks.
For the first time, ordinary investors have beaten large hedge funds and caused them to lose billions of dollars. This event demonstrates the influence of social media and the power of coordination. This incident has caused the short-sellers to rethink betting against a company they think is in decline. From now on, institutional investors need to do their research on the sentiments expressed on social media platforms and discussion forums like Reddit before making any subtle decisions.
That’s all for this week! We hope you liked it and would love to know your thoughts in the comment section. This article is written and curated by Ronit Bala.