Retail investors turned the stock market on its head these past few weeks by investing in GameStop (GME). Big investment groups have lost in excess of $5 billion this past week; the biggest loser being Melvin Capital, a hedge fund that lost 30% of its $12.5 billion fund. On the other side of things, retail investors, the little guys, have been making huge returns in their investment. Wallstreet rarely loses out to ordinary investors, so what happened here?
GamesStop was seen as a dying business at the start of this year, and the big investment firms saw this as an easy short selling opportunity. Short selling is profitable when a stock decreases in value after you make your purchase. The way short selling works is that an investor receives a stock from sellers on loan. Like a traditional loan, the seller intends to make money when the buyer gives it back with interest. In a short sale, the buyer sells the loaned stock on purchase with the intention of buying it back later at a lower price when they have to pay back the loan. For example, let’s say you are loaned a stock that is selling at $10. After receiving the stock, you turn around and sell it for its current value of $10. Then, when it is time to repay the loan, you see the stock value has dropped to $5, so you rebuy the stock at the lower price and make a $5 profit.
This is the scenario large investment firms were expecting to happen with GME stock. They took up a large amount of stock with the intention of having the price plummet so they could make easy money. Unfortunately for them, members of a reddit forum called r/wallstreetbets saw GME as being massively undervalued and took the opposite position, betting that it would increase in price.
A man named Keith Gill, who is better known by his pseudonyms RoaringKitty and u/DeepFuckingValue, made a post to wallstreetbets back in July that contained an in-depth analysis of GME and why he believed it would increase in value.He noted that GameStop was put under new management and undergoing restructuring. In addition, he saw the release of the new PS5 and XBOX Series X at the end of 2020 to be good for GameStop. He continued to post updates to his YouTube channel over the next 6 months detailing how his investments in GME were making money. As confidence in GME stock price increased, more retail investors who subscribed to r/wallstreetbets jumped on the train and invested, which increased the stock price even more.
What caused the value to increase by several hundred percent in the past two weeks though? The answer lies in the previous positions the large investment firms made when they thought the value of GME would drop. Regardless of how the price changes, they are obligated to pay back the loans they took. This can lead to a scenario called a short squeeze, as the price of a stock skyrockets, people who bet on the price dropping are forced to buy to prevent further losses. This increased volume of sales further drives the price up.
Free trade brokerage services like Robinhood and WeBull prevented users from buying GME stocks late last week as demand soared. This appears to purely be a liquidity issue. These companies didn’t have the cash to insure all of the trades. Users believed that Robinhood was attempting to manipulate the market in favor of their larger investors like Citadel, that were losing billions and are looking into class action suits against them.
The massive investment firms and financial media have come under fire for their response to the whole situation. There have been cases of the r/wallstreetbets investors being villainized and, to an extent, infantilized. CNBC’s “Halftime Report,” for example, said that the retail investors from places like reddit are being irresponsible with their money and that shutting down sale of GME was protecting them. Critics of this line of thinking point to the 2008 financial crisis in which Wallstreet and huge firms took enormous amounts of risk that lead to the market crashing. They were bailed out by the federal government and allowed to keep trading, while the average person took the brunt of the recession.
At the end of the day, trading on the stock market always has risks. It is a volatile market, and, in this instance, the hedge funds lost a bet. For many this is an empowering moment that shows an everyday person can influence the market and make money with smart investing. Robinhood, Fidelity, and many other brokerage firms are seeing an unprecedented increase in applications as this situation brought investing to the forefront of many young people’s lives.