By now, you've probably heard about the absolutely insane rally GameStop's ($GME) stock prices have had over the last month or so. While it's a process that's actually been quietly happening for many months, the snowball effect of Reddit's coordinated campaign to drive GME's prices up while squeezing major Wall Street players who shorted the stock has reached a tipping point where it can no longer be ignored.
A Quick Explanation of Short-Selling:
If an investor believes the price of a particular stock will go down in the future, shorting the stock can be a way of making money off the decline. Essentially, the investor borrows shares from an actual shareholder and sells them at current market price, then when the price declines in the future, they buy them back to return to the original owner while pocketing the difference as profit. EX: I want to short EBW so I borrow a share from PepperPeanut, and sell it at current value (let's say $10). When EBW's inevitable decay continues next week and the price falls to $7, I buy it back and return it to Pepper, and then I go buy some chicken tendies with the $3 profit I made.
Melvin Capital, which held a massive short position in GME, was actually forced to close out its entire position this week and additionally required a multibillion-dollar bailout from another hedge fund, Citadel. Citron Research, another firm notorious for its short positions, was similarly cowed into silence on Twitter by an army of retail investors who openly ridiculed Citron head Andrew Left when he predicted the stock would crash to $20 last week.
Financial news outlets are scrambling to cover these unprecedented events - but that's just the thing... they aren't ACTUALLY entirely unprecedented.
The concept of a 'bear raid' - when a group of investors bands together to drive the price of a stock down, possibly by shorting it - has been around for hundreds of years. Short-sellers are not popular in the market because they're betting on things to go down while business owners and most investors are, understandably, hoping for prices to steadily rise. As a result, there have been plenty of attempts through history to squeeze short-sellers.
Notably, Piggly Wiggly grocery chain founder Clarence Saunders tried to halt a bear raid on his company by taking out millions in bank loans and buying up HUGE chunks of shares to drive prices up. Unfortunately for him, his position and debts eventually became untenable, and he eventually had to declare bankruptcy.
Fresh produce and sticking it to short-sellers. This store had it all!
What's different about the whole GME situation from previous short squeeze attempts is that this whole game has been blown wide open with the introduction of low-cost/free trading apps like Robinhood and the burgeoning popularity of investment subreddits like r/WallStreetBets (WSB) and r/pennystocks. These tools have helped millions of new retail investors (ie, regular Joe Schmoes as opposed to big-time Wall Street firms and traders) find low-cost entry points into the market, share research and advice with each other, commiserate over failed bets, and bond over their mutual disdain for the Wall Street class whom they (rightly or wrongly) have regularly seen getting away with what seems like murder.
Wall Street and short-sellers in particular also drew the ire of this new investor class when, earlier this summer and fall, firms like Citron published bearish positions on other 'meme' stocks like NIO ($NIO), Plug Power ($PLUG), and Palantir ($PLTR), all of which saw significant surges to their prices as they became popular on WSB. Reddit investors saw this as the firms using their influence on fairly promising new companies in popular sectors as a way for these firms to drive down the price of these stocks for their own gain so they could scoop them up at a discount.
GameStop was essentially the perfect storm of all these factors coming together at once. As we previously discussed in our coverage of this story, while the company was undoubtedly floundering, it still had some life left and could also turn things around with new leadership (which came recently in the form of former Chewy co-founder and current investment world darling, Ryan Cohen). The fact that short interest on the stock was well over 100% meant that the short positions were way overleveraged, believing that GME was circling the drain to bankruptcy. This hubris is what made them ripe for the plucking.
More and more users on WSB started to realize that if they all kept buying shares of GME, the price would eventually move up to a point where short-sellers would be forced to buy stock themselves so they can cover their positions... driving the price up even further. It's a feedback loop that, as of now, seems to just keep spiraling upwards. The vast influx of new, young traders who weren't groomed in the old-school Wall Street ways of investing saw this as a chance to score some quick profits while simultaneously taking some douchey, pessimistic billionaires down a peg.
"What we're seeing is essentially a pushback against the establishment in a really important way." @Chamath discusses how he traded GameStop, and encourages those dismissive of the phenomenon to visit r/WallStreetBets and read what users are saying. https://t.co/yI7kptqiqe pic.twitter.com/sEXMAJkcG5— CNBC (@CNBC) January 27, 2021
So here we are. With each new article or news clip about this crazy turn of events, more and more people are stepping in from the sidelines. I have MULTIPLE friends who threw a little money into investments for the first time ever this week. Forums like WSB have gained so much traction and convinced so many people to buy in, Reddit has essentially become its own hedge fund with a collective buying power to rival any firm on Wall Street. If these investors can also maintain discipline like the big boys, those other firms ought to be very, very scared.