And how did we get here?
First some basics:
- Shorting a stock means betting against it. To bet against a stock, you borrow the target stock from someone else, with a promise to return it later. You immediately sell the borrowed stock, with the goal that you can buy it back later at a lower price and profit the difference.
- Shorting stocks is much riskier than buying and holding a stock for long term appreciation. Simply, if you buy a stock to hold, the most you can lose is 100%, your stock goes to $0. If you short a stock, your risk is unlimited. The stock can appreciate with no upper limit, you will still have to buy it back and return the borrowed shares.
- Short selling can be great for a healthy capital market, it can do the work that rating agencies are less efficient at. Where there is profit to be made in a free and open capital market, prices will sort themselves out efficiently. There are many who feel short-selling creates no value to society and is bad. This topic is for another article on its own.
- A short squeeze is when the stock that is being shorted is bid higher and higher, eventually forcing those with short positions to buy it back to limit their losses.
So, what happened? Some astute traders discovered that GameStop shares, (ticker symbol “GME”) were being shorted by billion dollar hedge funds. In an online Reddit community called “r/wallstreetbets,” members managed to gather support from many other retail investors to start buying shares of GME on mass, bidding the price higher and higher. It worked, and the short sellers, big billionaire hedge funds got squeezed. In order to close their short positions, they had to sell shares of other companies to be able to create enough cash to buy back GME shares that in some cases had risen many times higher (up to 1000% -2500%). These hedge funds lost billions.
The little guys who scored this “victory,” had their parade cut short. Robinhood, is a free trading platform for small individual US investors where much of this trading took place. Robinhood halted trading at some point yesterday, meaning its customers could only sell GME shares and not buy them. This lead to an uproar, but today it seems some trading has partially re-opened. The reasons for the halt to trading probably has something to do with the clearinghouses Robinhood uses not wanting to take on the risk of settling these trades. You can read more about that in the first article linked below.
There are so many lessons and angles to be explored from this event. For retail investors, one important lesson is that nothing is free. If you are using a free trading platform like Robinhood, YOU are the product. They are selling trading data milliseconds after customers trades are entered so bigger high frequency traders can front run and buy the shares slightly lower and fill your order, arbitraging a small profit. I can go on a side tangent on Robinhood, as there are many other issues here, but I digress. At this point, it’s also not clear that most of the trading in GME is even from retail “Reddit” traders anymore but from other professionals and hedge funds (but that’s not as sexy a story).
Day trading is entertainment, it is not investing. It feels good to see the narrative as the little guy sticking it to “Wall Street”. And a sense of FOMO can lead investors to take risks they have no business taking. In reality, those who play stupid games, win stupid prizes. Most of these traders don’t know what they are doing and will be left holding the bag. I prefer not to worry about this and stick with my boring diversified portfolio. But I acknowledge the excitement is real and hard to ignore.
Extra reading on this topic for the nerds:
There are so many sides and dimensions to this story. If you want to understand as much as possible, or a specific angle, this article from Matt Levine, is the one to read above them all:
Reddit Traders on Robinhood Are on Both Sides of GameStop – Bloomberg — www.bloomberg.com
Retail flows, clearinghouse margin, short sellers, lawsuits, Roaring Kitty and Nottingham.
“The real story is the one that lies underneath: it is the story of the source of cascading events in markets, of short squeezes and events in which those squeezes lead to large de-grossing events in which funds rapidly reduce their exposure and cause the kind of broader market events that do have real-world effects. It is the story of the heel of Achilles, the shoulder of Siegfried, the kryptonite of Superman.
It is the story of leverage.”
The Invulnerable Hero* | Epsilon Theory — www.epsilontheory.com
No, the real story here probably isn’t about a revolution against Wall Street. But that doesn’t mean that there isn’t an opportunity to build a movement – right now – to transform it toward fair, free and open markets. Read more
“Unless institutional investors bail out individuals by purchasing their GameStop shares, which seems unlikely, the public will lose that which it has gained.”
With GameStop, Hedge Funds Might Enjoy the Last Laugh | Morningstar — www.morningstar.com
If stock prices become irrational, hedge funds rather than individuals stand to benefit.
“his whole story is really a story about counterparty risk. Actually, the entire historical story of finance is all about counterparty risk. For every buyer there’s a seller. For every borrower there’s a lender. There’s two sides to all these transactions in a monetary economy.”
Three Things I Think I Think – GAMESTONK! – Pragmatic Capitalism — www.pragcap.com
I’d love to talk about the mechanics of Central Banking or index funds, but the only thing that matters in financial markets right now is Gamestop. So…we’re going to talk [ … ]