What’s Up with Wall Street? Simplifying the Short Stock Situation

Snoo, the reddit Alien, can be seen as the mascot for the popular forum Reddit. R/Wallstreetbets, a reddit stock trading forum, led the charge of a massive debasing of investment firms which were shorting gaming ancestor GAMESTOP(GME).

The internet’s been in an uproar over GameStop and AMC stocks skyrocketing over the last two weeks. A subreddit took up arms against Wall Street short sellers, causing hedge fund owners to lose billions in a shockingly short time. 

It’s a crazy situation, but lots of people who don’t understand the Wall Street lingo might not understand exactly what’s going on. Why would a failing game retailer and a theater chain suddenly gain so much value in such a short time? 

To understand the situation, we first need to understand what short selling means and why investors use it. In essence, to “short” a stock is to sell it at a high price, then buy it back later at a lower price, keeping the difference as profit. Sounds simple enough, right? 

Wrong. There’s a catch. Before being able to short a stock, you first have to borrow the stock from somebody else, introducing a risk factor. So if you try to short sell a stock, but instead the price rises, you’re still obligated to return the stock, even if you have to buy it back at a higher price to do so. 

Enter GameStop and AMC. Once the king of video game retailers, the rise of digital downloads have knocked GameStop down to the gutter, while AMC’s stock price has been plummeting since the pandemic.

GameStop’s share price sat at about $18 at the beginning of 2021, a poor number compared to the $55 share price they boasted in 2007. Betting against GameStop and AMC seemed like a no-brainer. 

Then Reddit got involved. A popular subreddit called r/WallStreetBets noticed that several hedge funds had taken shorts against GameStop and AMC. The subreddit, which now has over 8.5 million members, decided to all collectively start buying stock in GameStop and AMC. 

On January 27th, GameStop’s share price peaked at nearly $350, almost twenty times the price on January 1st. AMC saw a similar spike, rising from under $2 on January 1st to almost $20 on January 27th. 

But why? These companies are still failing, why would buying them up in huge quantities benefit the buyers? The answer is simple: it doesn’t. R/WallStreetBets didn’t buy GameStop and AMC in spades to make money, they bought it to spite hedge funds, knowing they would lose money. And lose money they did. 

“Hedge fund Melvin Capital sustained huge losses and was forced to close out its short position in GameStop,” wrote Rani Molla in an article for Vox. “Another GameStop short seller, Citron Research, announced last week that it would stop publishing short selling reports entirely.” The same article estimates that hedge fund investors lost a collective $12.79 billion on GameStop alone. 

Being forced to close on a short position is the last thing you want. After selling low, funds are forced to buy high to return their borrowed shares. 

Meanwhile, r/WallStreetBets is determined to “hold the line.” There are thousands of posts a day from members encouraging each other to hold onto their shares to squeeze the hedge funds for as long as possible. 

Most people investing at this point are investing knowing they’re going to lose money, but pandemic fatigue combined with a growing divide between society and the 1% makes sticking it to the man. They’re okay with losing $100 as long as it costs the hedge funds more. 

GameStop and AMC’s artificially high prices can’t last forever, and they’re already starting to normalize. But the damage is done, the flaw in the system has been exposed. Already, the SEC is coming down hard with new regulations meant to prevent future short squeezing. Will it be enough? We won’t know for some time.