Hello, financial aficionados! By now, you've likely heard about the GameStop drama that took place in early 2021. If you haven't (were you living under a rock?), get ready for a deep dive into one of the stock market's wildest tales.
But before we dig into it, I thought it would be useful to do a recap of a couple financial concepts, as they are key in the GameStop saga.
Short and long position
These are terms for phenomenon that you read and hear very often when trading stocks.
- Long position: when an investor takes a "long" position, they are buying shares of a stock with the expectation that the stock will rise in value over time. The idea is simple: buy low, sell high. Going long is the most straightforward way of investing in stocks and is how most people start investing.
- Short position: taking a "short" position is the opposite of going long. When you short a stock, you are betting that its price will decrease. The process is a bit more tricky than the long one:
- You borrow shares of the stock (through a special contract) from investors that own the stock and plan to keep it for a long term.
- You sell the stock at the current market price with the hope of buying them back later at a lower price.
- You buy back the stock (hopefully at a lower price) and return the stock to the original owner.
- If everything went well, the delta between the original selling price and the purchasing price will be your gain. Normally the owner gets compensated with some interest rate, however the cost is lower than your gain.
A short squeeze is a market phenomenon that occurs when the price of a stock rises sharply, forcing traders who have shorted the stock to buy shares to cover their positions, which in turn drives the stock price even higher. Here's how it works in detail:
The Setup for a Short Squeeze:
- Short interest: a stock with high short interest (a large number of shares being shorted) is a candidate for a short squeeze. The short interest is often expressed as a percentage of the stock's float, that is the number of shares available for trading. It excludes shares held by insiders, company officers, and major institutional investors, as these are generally considered less likely to be traded on a regular basis.
- Initial price increase: the stock experiences an initial increase in price due to any number of factors—good earnings, positive news, or even market rumors. This initial price jump triggers the squeeze.
- Covering: traders who are shorting the stock start to buy shares to cover their short positions. This is often a requirement if they're trading on margin and receive a margin call, but it can also be a voluntary decision to prevent further losses.
- Price surge: the additional buying pressure from short sellers covering their positions can drive the stock price up even further.
- Feedback loop: the rising price can trigger additional margin calls or stop-loss orders, forcing more short sellers to cover their positions. This creates a feedback loop, driving the stock price even higher.
- Unwind: eventually, the buying pressure subsides, either because most short positions have been covered or because new sellers enter the market, believing the stock to be overvalued after the rapid price increase. The stock price may then stabilize or even decline.
Too complicated? Let's try how I would explain it to my kids. Imagine you borrow a friend's toy, thinking its popularity will wane, and you'll be able to buy a replacement for cheaper in a week to give back to him. But instead, the toy becomes super popular, and everyone wants one. Now, the price has shot up!
You still have to return the toy to your friend, but to do so, you have to buy it at the higher price. The act of buying the toy pushes the price even higher because so many people are scrambling to buy the same toy.
In stock terms:
- You "borrow" a stock and sell it, betting the price will drop.
- Instead, the price goes up.
- You buy the stock at the higher price to "return" it.
- This buying drives the price up even more.
Act 1: GameStop's humble beginnings
Remember the nostalgia of wandering into a GameStop, money saved up from allowances, eagerly searching for that next video game? With a business rooted in physical stores and tangible game copies, GameStop seemed like a dinosaur in the digital age. By 2020, industry giants were betting big on GameStop's decline. Shockingly, around 140% of its shares were shorted. If you are now scratching your head, I feel you. How can a company have more than 100% of its floating stock being shorted? The key really is recognizing that shares can be lent multiple times. Here's a simplified example to illustrate how this could happen:
- Initial ownership: investor A owns 100 shares of Company X.
- First short: short seller B borrows these 100 shares from investor A and sells them. The buyer of these shares is investor C.
- Second short: now, investor C owns 100 shares. These shares can be lent out again. Short seller D borrows the same 100 shares from investor C and sells them to investor E.
- Total short interest: at this point, 200 shares have been shorted, even though the company only had 100 shares in float initially.
Act 2: r/WallStreetBets and the great rebellion
Enter stage left: r/WallStreetBets (WSB), a rowdy bunch of internet traders on Reddit. Some users believed that not only was GameStop undervalued, but also that they could turn the tables against institutional investors by triggering a short squeeze.
The discussions were more than just cold calculations. They were rebellious, filled with memes, inside jokes, and a shared sense of purpose against the financial elite. For many, it wasn't just about money; it was personal.
Fun fact: enthusiastic members of the WSB community funded digital billboards across the US and even flew banners from planes supporting the cause
Act 3: the siege of Wall Street
With more retail investors jumping on board, GameStop's stock price rocketed. This wasn't a gentle rise; it was a jaw-dropping, rocket-strapped-to-a-rollercoaster kind of ascent. From an unassuming $20 in early January 2021, it touched a staggering $483 by January 28.
But what about the big financial institutions? While some hedge funds doubled down on their short positions, others sought emergency cash injections. Several funds faced monumental losses. The playing field had been flipped.
Fun fact: From Bankruptcy to Billionaire: One Reddit user, known as u/DeepFxxxingValue, turned a $53,000 investment in GameStop into millions, providing regular updates on WSB.
Act 4: more stocks join the fray
GameStop wasn't the only stock to bask in the Reddit limelight. AMC Cinema, another company facing pandemic-driven challenges, was next on the list. Buoyed by the GameStop success and an unyielding sense of momentum, the WSB community turned its gaze to this beleaguered cinema chain.
Fun fact: By June 2021, AMC's stock price increased by 1,100 per cent, boosted by retail investors from WallStreetBets Reddit board. AMC rewarded all these new investors with a large bucket of free pop corn.
Act 5: the reality check
No financial frenzy is without consequences. The GameStop spectacle brought forth concerns about market manipulation, the democratization of finance, and the role of social media in modern investing. And among many things, even the at the time GameStop CFO, Jim Bell, resigned in February.
Brokerages, caught off-guard by the sheer volume of trades, faced their challenges. Platforms like Robinhood had to temporarily restrict trading, leading to controversies, lawsuits, and Congressional hearings.
Act 6: looking beyond the hype
Once the dust settled, the GameStop saga left behind important takeaways:
- Digital mobilization: the digital age, combined with social platforms, can mobilize retail investors in unprecedented ways.
- Risk & reward: While some Redditors boasted about their newfound wealth, others faced steep losses. As the old adage goes, "Don't invest what you can't afford to lose."
- Regulation reckoning: the event triggered worldwide debates on market regulation, transparency, and the nature of financial advice.
Fun fact: Reddit capitalized on the saga with a five-second Super Bowl ad, hinting at the power of community
In conclusion: riding the meme stock wave
The GameStop episode wasn't just a quirky blip on Wall Street's radar. It was a manifestation of our digital age, the collective power of online communities, and the shifting dynamics between institutions and individual investors. For many, the line between serious finance and internet culture got delightfully blurry.
Fun fact: "Stonks" and "diamond hands" became popular internet slang, the former referring to stocks in a meme-like manner and the latter meaning holding onto a stock despite market volatility.
Whether you cheered for the Redditors, sympathized with the institutional giants, or simply munched popcorn on the sidelines, this event was a lesson in the unpredictability of markets.
Until the next meme stock saga rolls around, invest wisely and always enjoy the ride! 🥂