Reddit users following the popular thread r/Wallstreetbets/ recently shook America’s trading sector to its core after a coordinated mass-purchase of GameStop stock. The movement destabilised hedge funds across the US, leading to a loss of more than $13.1 billion. But how did the hedge funds lose so much money, and why is this such a big deal anyway?
To understand the effect of Reddit’s short squeeze, we need to break down exactly what “shorting” is. Hedge funds (a service where rich people will send their money to be invested by managers) practice something called shorting—a technique where a broker will borrow a stock, sell it immediately, then buy it back to return to the lender. To break it down, you borrow a stock from a lender, then sell it for $20. But then the stock’s price drops to $15. You buy it back for $15, and give it back to the lender. Congratulations, you’ve made a profit of $5! But like all things financial, shorting is a double-edged sword. There’s always the risk that the stock price increases after you sell, and when it comes time to buy it back so you can give it back to the lender you have to buy it back at its higher price, making a loss in the process.
Shorting is a technique responsible for lining the pockets of many hedge funds and their investors. Hedge funds looking to short will swarm middling companies—it’s sort of like the kiss of death for a business. So, when users on r/Wallstreetbets/ decided to rapidly purchase GameStop stock en masse, it was an unexpected, albeit genius, move. Melvin Capital, the hedge fund targeted by Reddit traders, closed out its GameStop short position after share reached eye-watering prices. The fund has been thrown a lifeline of $2.75 billion in a bailout attempt after losing almost 30% in the first three weeks of January. Reddit users are now combing through other hedge funds to discover other short exposures, and many others are taking a gamble and investing in inexpensive stock in floundering companies (like Nokia, Blackberry, AMC Theatres and even Movie Pass). The coordinated operation is completely legal, leaving many stock market pundits scratching their heads wondering how experienced investors got it so wrong.
One theory is that many of the followers of r/Wallstreetbets/ are younger adults who grew up during the Global Financial Crisis and witnessed Wall Street being bailed out, after causing one of the greatest economic disasters in history. The hurt and suffering were palpable even in lucky countries such as Australia, and the stress caused by suit-and-tie banking executives who got off Scot-free created a lasting distrust in financial institutions amongst young people. Popular investing apps such as Robinhood were the site of the mass-buy, demonstrating that young people turn to smaller, less traditional investing platforms when seeking to dabble in the stock market.
But even the apps favoured by these new investors found the pressure of Wall Street too much. The aforementioned Robinhood has placed a hold on the purchase of GameStop, AMC and Nokia stock, drawing criticism from users for manipulating a free market and blocking totally legal purchases of stock. The inability to purchase has many users refusing to part with their lucrative shares, since the lack of demand will devalue their stock and re-line the pockets of hedge fund managers. The popular app now faces a class-action lawsuit for blocking their users from freely trading and exploiting the same loopholes as their institutional counterparts.
The move to swarm middling companies with sudden investments even drew attention from the White House, however Press Secretary Jen Psaki assured US citizens that the GameStop saga “is a good reminder that the stock market is not the only measure of the health of our economy and it does not reflect how working and middle-class families are doing.” Psaki’s statement has since come under fire after it was disclosed that she has earned more than $7 million USD in speaking fees from Wall Street firms—one of them being Citadel, the parent company of Robinhood.
Data analytics firm Ortex has shown that US short-sellers are sitting on an estimated $71 billion loss, and as amateur traders continue finding companies with high short stock ratios this loss is expected to increase. GameStop stock has fallen as of the 29th of January. However, its rapid rise and potent effect on some of the most significant financial institutions across the globe have proven that the collective action of individuals against monolithic hedge funds prevails—what this realisation sparks, is yet to be seen.