It probably won’t be long now until you see someone drive up to a fancy restaurant in a limo sporting a white tuxedo, and you’ll casually ask that person, “How did you get rich?”, and they will reply, “I invested in GameStop!”
In early January, GameStop was sitting at somewhere around $18.00 a share. On January 26, it hit a peak of nearly $483.00. Besides the ridiculous amount GameStop stocks have surged in just one short month, there is even a far more fascinating story behind why it surged.
First, we will start with a quick refresher on “shorts”, and not the kind you wear during the summer. A short occurs when an investor borrows a share of stock from another investor and sells it, hoping that the stock drops in price later, and therefore he can then repay the lender back a share of the stock at a now lower price and keeps the difference for themselves. For example, let’s say the price of a share of Rachael’s Roses is $10.00. An investor, believing Rachael’s Roses will see its stock price dip soon, borrows shares of the stock from another investor and sells it. Now, let’s say the price of this share drops to $3.00 a share. The investor rebuys the share at just $3.00 and repays the lender the share of Rachael’s Roses. So essentially the investor made $7.00 because he sold the share of the stock he had borrowed for $10.00 while then returning the share of the stock when it was only $3.00. This is called “shorting the stock”. While this example showed the investor making money of his “short”, if the price of Rachael’s Roses had increased to $17.00 a share rather than decreased, the investor who “shorted” would have lost money. Now, to GameStop.
There was a large group of investors who were shorting GameStop. They had borrowed and sold short billions worth of GameStop stock in the hopes that it would decrease, and therefore making a boatload on their short. There was just one minor miscalculation the investors apparently made: Reddit.
There are different versions of what prompted the astronomic rise of GameStop, but the most common explanation found is what follows: a group of users on Reddit had noticed large amounts of shorts placed on GameStop from these hedge-funds. In essence, Wall Street was betting against GameStop. These Reddit groups, seeing that GameStop was being shorted in the billions by hedge-funds, decided to begin buying shares of GameStop and encouraging others to do so as well. There have been arguments made that others were buying GameStop for different purposes, whether to salvage the company or simply in the belief it would rise in value through increased sales. While the latter reasons were probably valid and a rationale to buying GameStop, the most prominent reason was the former—as an impromptu slap-in-the-face to the billionaires and their hedge-funds. And there certainly was a message sent: it is estimated that short sellers lost approximately $23.6 billion dollars on their attempted gamble in shorting GameStop (NBC).
The most disturbing part of the story came later, as GameStop stocks were surging causing mayhem for all the short sellers, trading platforms from Robinhood to TD Ameritrade began blocking their users from buying GameStop shares. The claim has been from these companies that they were trying to prevent some sort of market volatility, but inevitably, this caused GameStop shares to sink temporarily and gave enough time for some short sellers to cover their losses.
When discussing the stock market and investing with everyday people, as an investment firm we find there are numerous individuals who share a certain “distrust” of the investing world—we often hear similar phrases from them such as the market being like a “casino” and how it is “rigged” for the wealthy. What happened with GameStop has only re-enforced that perception. Short sellers on GameStop made a gamble: they bet that the stock would go down. People on Reddit organized and bought the stock making its value increase. The short sellers lost money. The story should have ended there. When these companies like Robinhood, whose popularity rose because they allowed everyday people to trade stocks without paying commission fees (disclaimer: nothing is ever entirely ‘free’), suddenly decide to limit people’s ability to trade, there becomes a serious issue. People have had this perception of a “rigged game” when it comes to trading in the stock market, that those with money have advantages over the populace. What happened last week added massive fuel to that fire because these trading companies helped the short sellers avoid bigger losses than the already 20+ billion they had suffered. These short sellers made a gamble on GameStop, and they lost. What Robin Hood did is the equivalent of a casino house shutting down after someone won 3 poker games straight against the richest man in the club. If people had the belief that the stock market was rigged against them, the ordeal last week certainly did not help.
Now companies like Robin Hood and TD Ameritrade among others will likely face some type of Congressional investigation; though I would not hold my breath that anything will come of it. They will simply claim they were acting in an attempt to stop extreme market volatility. Nobody knows except themselves what their true motives were, but I will leave you with this one thought to ponder: if GameStop shares had collapsed instead of surged, and the short sellers were making the billions instead of losing billions, do you think Robin Hood and others would have stopped the trading of GameStop on their sites to avoid “market volatility”?