Gamestop: Small retail traders and investors from the Reddit community just successfully played the system, beating bigger and more powerful traders at their own game.
In what seems like a modern-day twist to the Robin Hood story — a gaming company’s stock Gamestop has become a battleground between the rich and the poor with Reddit users attempting to bankrupt hedge fund managers.
US company GameStop is a brick-and-mortar video game retailer that has been struggling with profits due to store closures, a decline in physical sales, and the COVID-19 pandemic.
Its stock has been hovering between $4 and $10 for much of the past year is now trading at $325!! As of 29th Jan 2021.
Individuals investors, many from the Reddit group that has nearly 5.5 million members, have driven the share price up using an app called Robinhood. It permits anyone to trade stocks without commission.
Billionaire Elon Musk’s tweet added more fuel to the fire when he tweeted a link to the Reddit message board.
GameStop surged heavily in extended trade after Elon Musk tweeted ‘Gamestonk!!’
Why have Reddit investors targeted Gamestop?
Melvin Capital, the $12.5 billion hedge fund founded by Gabriel Plotkin, was one of the main targets of the campaign after an SEC filing revealed that the fund had a large short position in GameStop.
Short selling is a method of making money off a stock if the share price goes down, and GameStop had been one of the most shorted stocks on the market when the Reddit group targeted it.
The group noticed that GameStop stock, the struggling brick-and-mortar video game retailer, was heavily shorted by hedge funds.
The retail investors and short term traders on Reddit, many using free trading apps such as Robinhood, have been buying GameStop stock at high volumes to drive the price up and forcing panicked hedge funds with short positions to buy shares of their own to cover their short positions, further fueling the surge.
This happens when a stock price that was expected to fall actually rises and the short sellers have to buy back the stock to cover their shorts, driving the price up further.
US-based hedge fund Melvin Capital took out a large short position in Gamestop and has reportedly been bailed out with more than $2bn to cover its losses.
What is a short squeeze?
A short squeeze is a unique phenomenon where short-sellers in a stock who have placed their bets on a stock’s fall, rush to hedge their positions or buy the stock in the event of an adverse price movement, in order to cover their losses.
This leads to a sharp rise in demand for the share and a huge rally in share prices.
For example, if a trader expects that the price of stock A would fall to $ 100 from $ 120, he might take a short position in the stock to sell it at $ 120. However, if the stock price of the company starts rising, and jumps to $ 150, the short seller starts incurring huge losses — as he sells the share at $ 120 and delivers it after buying from the market at $ 150.
In order to minimize his loss and cover short positions, the trader who was initially short on the stock starts buying the stock, which leads to a sharp rise in the share price of the stock. A situation, where the short seller is buying the stock to cover his short position, is referred to as a short squeeze in market parlance. It leads to an astronomical rise in share price, far beyond its fundamentals.
How short squeeze work?
In developed markets, hedge funds and other big investors have to disclose their short positions in any company’s stock, if it crosses a certain threshold. And as an investor, anyone can find out such positions in the market. Then they can target a fund’s position by organizing and buying that stock, and forcing the short seller to reverse their position.
In the current scenario, investors have organized on message board site Reddit to buy and accumulate such stocks. Once the stock price starts to rise, the short-sellers are forced to buy the stock in order to hedge their position and cover their losses, leading to a huge surge in stock prices.
The surge in stock prices ultimately had little or nothing to do with GameStop’s strength as a business. As investors following the Reddit group bought a ton of GameStop shares and call options. Short-sellers were forced to buy shares to cover their losing bids — thus boosting the share price even further.
THE BUBBLE WILL BURST……EVENTUALLY
An argument may be made that GameStop was undervalued, but hardly anyone believes that GameStop or any of the other companies that the Reddit crowd is promoting have the fundamentals to support such sky-high prices.
At some point, reality will set in.
But that’s the problem with bubbles — get out too early, and you lose at a chance to cash out at the top. So, GameStop keeps surging … until it doesn’t.
“Someone is going to get hurt,” As happens with crowd behavior, you end up having people come in at the end at a very high price and getting burned.”
The Securities Exchange Commission coming down on WallStreetBets and other online stock forums, but the tricky part is there is no evidence of fraud or insider trading. All of this information is being exchanged in the open public forum.
Several stocks in the US, the UK, and other European markets are witnessing this phenomenon. And certain companies are seeing a staggering rise in their share prices. Many other stocks across Europe are witnessing this phenomenon, which market participants say will force hedge funds to watch out for their short positions.
If we see some more short squeezes in the coming days, we may witness a sharp correction in world indices. As hedge funds will be forced to sell their top-performing stocks to cover their losses in their short positions.
What is your opinion about Gamestop euphoria? And what lessons to be learned from this episode!!!