It’s all over the news — “GameStop” followed by “stocks” followed by “surge.” But what is actually going on, and what does it mean for regular investors?
First, let’s recap the basics of what happened.
This whole situation started with Reddit — an online forum that is divided into various communities, called “subreddits,” for different interests, according to Reddit’s website. Within the subreddits, people can post, vote, comment and hold discussions.
A group of Reddit users part of a forum called “r/wallstreetbets” saw that hedge funds were short stocking seemingly dying companies like GameStop, according to The Guardian. So, in an effort to take on Wall Street, they came together and bought as much GameStop stock as possible, making the price rise exponentially.
According to NBC News, GameStop’s stock price has increased by about 8,000% over the last six months. This sharp increase in the stock price caused the hedge funds’ short stocks to lose billions of dollars, forcing them to close their short positions and buy back GameStop stock at higher prices, further driving up the price.
Long story short — what happened went viral. Now, people are starting to do the same thing with other companies hedge funds are betting against, such as the cell-phone maker Blackberry and AMC Theatres, in order to take them down, according to CBS News.
But let’s walk through what all of this means in layman’s terms.
What is short selling?
To explain short selling, let’s start by discussing what a hedge fund is. Hedge funds pool money from investors and invest in securities or other investments to create a positive return, according to the U.S. Securities and Exchange Commission’s website.
However, hedge funds are for wealthy investors “who can afford the higher fees and risks,” according to the SEC. Basically, they aren’t for your everyday person trying to invest to pocket a little bit more money to help put their kid through college.
Hedge funds “have been shorting stocks like GameStop” along with other companies that are dying off and whose stock value is expected to decrease, Pat Franckhauser, a financial adviser based in Dallas, said.
“[Hedge funds] borrow the stock at a certain price — let’s say $10 a share — and when you short it, you borrow it at $10 knowing that it’s going to go down to, maybe, $8 because you don’t have to pay for it when you borrow it,” Franckhauser said. “You don’t have to pay for it for several months, depending on the length of the term.”
So, once the hedge fund has to pay for the stock, they’re buying it at a lower price than what they borrowed it at, Franckhauser said.
“Then they can turn right around, hold onto it, or make money on what they borrowed versus what they paid for it,” Franckhauser said. “So, they’re trying to make money by just manipulating the market because they think the stock is going to go down. It doesn’t add any value to the marketplace, and it’s despised by regular investors. They kind of look on these big hedge funds as bad guys.”
What is short squeezing?
As mentioned earlier in the recap, once people on Reddit found out that these hedge funds were short selling GameStop, they began buying up stock, which caused the price to increase drastically, Franckhauser said. Many were putting money into the stock through investment apps that don’t charge people to buy stocks.
If the stock goes up instead of down, which was the case with GameStop, short sellers have to buy the shares they borrowed to prevent more loss.
“So now the value is going up, but these hedge fund people that bought it at $10 expecting to go to $8 — well, now, it’s at $400 a share,” Franckhauser said. “And they have to buy it at $400 because they borrowed it. So they’re losing hundreds of millions, if not billions, of dollars.”
Is the hype worth buying into?
According to Franckhauser, the answer is, “No.”
“I’ve heard that people are putting all their retirement savings, everything they got into this thing, which is not a good thing to do,” Franckhauser said.
Since GameStop’s stock is “nowhere near what it’s selling for,” it will crash, and “it’s just a matter of when, and who goes with it,” Franckhauser said.
Franckhauser noted that GameStop was struggling for a while, but because of the COVID-19 pandemic, people started buying more video games to pass time in quarantine. So, while GameStop’s stock was starting to go up some, now it’s being “artificially driven up.”
“It’s not going to end well because GameStop does not have the business to support the current stock price, so it’s going to go back down,” Franckhauser said. “And somebody’s going to get hurt — a lot of people are going to get hurt when it does. And it could go down in a day — by 1,000 fold in a day.”
Will this affect ordinary investors?
“Probably not,” Franckhauser said. Those who aren’t investing in GameStop or any other companies hedge funds have been short selling being discussed on social media shouldn’t have any problems.
But, Franckhauser said, “nobody knows yet — we’ve never seen this before.”
“I don’t think it’s going to be a big deal, except it could be artificially driving the whole market up right now,” Franckhauser said. “A lot of this is being driven by three or four or five stocks, so there could be some repercussions.”
Did Reddit users beat the hedge funds at their own game?
The answer to this is unclear. Franckhauser said driving up stock prices in companies that hedge funds are shorting could become a trend “where smaller investors look for opportunities to stick it to the Wall Street hedge funds and make money just like they’re doing.”
However, Franckhauser said regulators will be and are already starting to get involved.
“The fact that it’s coordinated over Twitter and Reddit and some other social media sites — that’s probably not good, and that’s going to draw the attention of the people that regulate the markets,” Franckhauser said.
For example, one of the apps people were using to buy stock for no fee was Robinhood. It restricted trading stocks for certain companies, including GameStop, Blackberry, and AMC, on Thursday, according to The Hill. However, the company is now facing a class-action lawsuit for doing so.
And while what Reddit users and others are doing may be seen as unethical by those trying to regulate the market, Franckhauser made note of something important:
“What hedge funds do every day when they short sell — believing that the value of the stock is going to go down and hoping it goes down — that’s not necessarily ethical either.”