Everyone is talking about the recent surge in Gamestop’s stock price. This David and Goliath story of regular people taking on the giants of financial investment has shaken up the way we think about investing and has captured the attention of investors and non-investors alike. But what really happened?
Gamestop, a brick and mortar video game retailer with over 5000 locations based mainly in shopping malls, saw over 1700% growth in their stock price at the end of January 2021. This fluctuation wasn’t based on the fundamentals typically attributed to a spike but was purely a vendetta from amateur stock traders on Reddit against naturally dominant hedge funds.
In hindsight, it seems inevitable that a shakeup in the financial world would occur in this pandemic. With the pandemic came the sudden influx of people with newfound time on their hands, a platform to band together on, and the drive to earn a substantial amount of money in a short period – creating a perfect storm for disrupting force.
With the already controversial Robinhood app as their vehicle and getting rich their destination, many Reddit users allied to pull off what might be the most surprising and disruptive “short squeeze” we’ve seen in a decade.
What is a short squeeze?
To know what a short squeeze is, it is essential to understand what a short-seller is. Short-sellers are essentially people who borrow shares from a broker in hopes that they will go up in price in a short amount of time. They then sell the shares at that high price and pocket the difference when re-purchasing.
After acquiring the shares back, they return those shares at the new lower price to the broker. Since the stock market is known to fluctuate, shorting is seen as a very risky way to make money; however, it can be more than worth the risk if a short seller manages to pull it off. If there is a time the stock price goes higher than expected, short-sellers still need to return their borrowed shares but now have to repurchase them at a loss.
A short squeeze is when a stock rapidly surges to a high price, and short-sellers are forced to buy stocks at that higher price when they were expecting the price to fall. Gamestop’s situation was due to the Redditors buying up the stocks to target short-sellers explicitly, forcing them to sell at a significant loss.
It’s not like GameStop has ever been mentioned in recent years alongside other highly profitable stock options, so why was it chosen now?
Gamestop, after all, is an aging business model where they sell physical video games rather than through an online platform similar to Steam. This outdated practice resulted in low-priced Gamestop’s stocks – making it an optimal target for shorts to take place. This caught Redditors’ attention, many of whom have an affinity for the brand, and this affinity paired with the knowledge that the stock was frequently shorted, gave them a reason to pursue a short squeeze.
So What Happened?
Essentially, one Redditor with extensive knowledge of the stock market drove the push for change after recognizing what these short-sellers were doing with the Gamestop stock. Due to the small supply of stocks, it would be reasonably easy to drive up the stock price, leaving hedge funds out billions of dollars.
The Redditor posted on a subreddit called r/WallStreetBets, indicating what was happening in the financial space and many other Redditors began to participate in a short squeeze. Many started using their savings from staying at home during Covid to join the squeeze.
The way that they were able to pull this off was through a free app called Robinhood. Robinhood is based in California and is a stockbroker app that does not take a commission on trades and exchange-traded funds. Consequently, the fact that there are zero commission and easy access to the app has led to a surplus of day-traders on the app.
Robinhood’s response to GME stock’s frenzy was to make the very controversial move to freeze any GameStop stocks’ trades. Robinhood claims the reason behind the temporary freeze was a regulation issue.
According to Recode Daily, Robinhood needs to uphold that stock buyers have the money to pay for the stock. Therefore, Robinhood is required to post collateral with those who eventually process the trades.
In GameStop’s case, there were so many transactions happening when the stock started to surge that Robinhood did not have the funds to post collateral. Of course, many people were outraged – some alleging market manipulation, other’s attributing the move to a conspiracy to defend the hedge funds. The day after the ban, “limited buys” of the stock became available again, but unique options like fractional shares were no longer on the table.
Now, the authorities are involved, and there is a class-action lawsuit against Robinhood due to the temporary restriction. The main argument made therein is that hedge funds could still trade while those who were trading through Robinhood were unable to take action. Vlad Tenev, the current CEO of Robinhood, stated in a tweet that “these requirements exist to protect investors and the markets, and we take our responsibilities to comply with them seriously.”
Only time will tell where the future of Gamestop (and Robinhood) will land and the consequences that these free trading apps will face.
If there is anything to learn from Gamestop, it is that investing is a lot more accessible than some might think but can also be fraught with instability, questionable motivations, and pitfalls. There are many investment options out there, and contacting a financial advisor if you want to start investing is always the best place to truly understand how a stock portfolio can be a part of your financial picture.