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Saturday, October 23, 2021

GameStop, Reddit and the stock market: What’s the beef?


What happens when a number of Reddit users go to war with large hedge funds in support of a game retailer?

The stock market went through an immense volatility last month – the likes of which have never been seen before. It started when large traders tried to put GameStop out of business using a “short selling” tactic, which has for decades allowed sellers to make a lot of money at the cost of harming businesses.

However, this story played out differently this time, and saw a group of average investors unite on Reddit to fight back against short sellers to keep GameStop alive.

Before we dive into the details of the story, let’s cover what “short selling” and “short squeezing” actually mean.

Short selling is when a trader borrows a stock, immediately sells it, then buys it back at a later date for a lower price. The trader then returns the stock to its original owner. In essence, short-sellers are betting against the success of a stock, and make money when it goes down in value.

A short squeeze is when the value of a stock rises significantly during a short period. During a short squeeze, short-sellers can lose a lot of money as the stock goes up when they were instead betting against it. However, after a short squeeze, traders often short sell a stock as it’s expected to go down in value after a significant high.

In other words, short-sellers want a stock’s value to go down, and a short squeeze is when it goes up.

“GameStop, Cologne” by Sergey Galyonkin

What does any of this have to do with a video game retailer?

On this occasion, hedge funds such as Melvin Capital and Maplelane Capital believed the value of GameStop’s stock was likely to drop because the retailer st

ruggled during the pandemic. As a result, they took short positions on the stock, betting that its value will drop within a certain time.

This caught the interest of traders on Reddit, particularly on the Wall Street Bets subreddit, which decided to go to war with large hedge funds that make money by leeching on other businesses.

Elon Musk, an enemy of the short-sellers, joined in by tweeting “Gamestonk!!!” moments before the stock price surged. This led to a short squeeze that saw the stock’s value rise from $19 to $396 in just two weeks. This caused short-sellers to lose almost $20 billion in January. But the battle did not end there.

When the stock was at its peak, many brokers restricted trading on GameStop’s shares, allowing users to only sell their stock with no option for them to buy it. This caused the value to plunge from $396 to $132 within the same day.

Trading apps such as Robinhood faced immense backlash from their users who criticised the service for taking the side of the hedge funds. The unfortunate events opened the eyes of many people to market manipulation carried out large financial establishments. 

The stock recovered when the restrictions were lifted, only to slowly drop in the following days. While Redditors urged traders to hold on to the stock and take it to the moon, the rapid drop in the stock’s value drove some to cut their losses short and sell the stock.

GameStop’s share price now sits at around the $100 mark, which is five times higher than the $19 it started with earlier in the month, but four times lower than its peak. This, unfortunately, led to many traders holding on to the stock at a much lower price than they originally invested. 

Meanwhile, short-sellers appear to have capitalised on the drop of GameStop’s share price in the aftermath of the short squeeze to recover some of the money lost in their initial bet against the stock.

However, Reddit traders believe the fight is not over. Posts on the Wall Street Bets subreddit are encouraging others to still hold onto their stock and play the long game. A highly upvoted post on the subreddit reads “DONT [sic] BUY INTO THE PANIC. HOLD THE LINE”.

What is perhaps most surprising in this story is that it briefly united both the right and left-wing parties in America, with politicians across the political spectrum calling for investigations into why brokers such as Robinhood restricted trading of GameStop’s shares.

Commenting on the news, US Congresswomen and New York Representative Alexandria Ocasio-Cortez described it as “unacceptable”.

“We now need to know more about Robinhood App’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit. As a member of the Financial Services Cmte, I’d support a hearing if necessary,” she said in a tweet.

Veteran Republican lawmaker, Ted Cruz responded in “full” agreement.

It’s not yet clear how this story will end. Short sellers seem to have made some of their money back, while small traders are holding onto the stock and playing the long game. On top of that, politicians are launching investigations into what happened. This suggests the battle is far from over.

Have you invested in GameStop’s shares in the past month? How was your experience? Let us know in the comments.

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