In late January, one of the most interesting developments in investing history occurred. Small time investors, organizing on the subreddit r/wallstreetbets and trading though apps like Robinhood and E-Trade were able to apply significant pressure to several large hedge funds. In the past, big hedge funds have been making the power moves and big trades. This case was unprecedented because the hedge funds were the ones getting out-maneuvered and taking gargantuan losses. Before we get into the complexities of this very interesting story, it is important to first know some key vocabulary:
Short - Shorting, or short-selling, is when an investor borrows shares and immediately sells them, hoping he or she can scoop them up later at a lower price, return them to the lender and pocket the difference. (high risk)
Hedge fund - a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains.
GME - the stock ticker symbol for GameStop Corporation
Short Squeeze - A short squeeze occurs when a stock or other asset jumps higher, forcing traders who had bet that its price would fall, to buy it in order to forestall even greater losses. Their scramble to buy only adds to the upward pressure on the stock's price.
Around the twentieth of January, redditors on the subreddit r/wallstreetbets began purchasing shares of GameStop in a move due to speculative investing practices, as well as nostalgia. Once news came out that many hedge funds had aggressively shorted the stock, Gamestop began to surge upward, making the hedge funds' short position incredibly risky.
Why did they short GME in the first place? GameStop is not the retail juggernaut that it once was. As consumers look to online retailers for the purchase of video games more often, GameStop has found it difficult to generate business. For these reasons, many hedge funds shorted GME hoping to reap massive rewards in an anticipated collapse of the business; GME was the most heavily shorted stock on Wall Street.
As excited redditors began to buy up GME, the share price rocketed up from 35 dollars to 350 dollars. As this happened, news came out of short sellers losing over 5,000,000,000 dollars. Melvin Capital, one of the hedge funds with the most aggressive short positions on Wall Street, needed a 3 billion dollar cash infusion from several other wall street hedge funds and investment banks to stay afloat after major losses on GME.
As GME mania ensued and hedge funds took big losses, one of the most controversial plot twists in the short squeeze story occured.The online brokerage Robinhood, named after the ancient English hero who stole from the rich and gave to the poor, ceased the purchasing of GME, but still allowed its users to sell the stock, a move which can only negatively impact the stock. Robinhood was one of reddits’ most commonly used brokerages. Redditors claimed that Robinhood was siding with the hedge funds at the expense of the “little guy.” Robinhood, however, claimed that it made the move to prevent large losses on their end leading to the collapse of their business. Forty percent of Robinhood’s revenue came from one of the hedge funds that bailed out Melvin Capital.
Now that it has been a month since the GME rally and reddit’s short squeeze, there are several important takeaways. Small-time investors DO have the power to meaningfully affect the market. In the eyes of many of its former users who have since switched platforms, Robinhood failed to live up to their namesake and help the “little guy.”And finally the most important takeaway is that it is really entertaining to watch the hedge funds that have been pulling moves like this successfully for years finally lose so spectacularly. All good things must come to an end however and leading into early February the hype around GME began to fade and at the time of writing it currently sits at 46 dollars a share.
By: Joseph Shull