I loved reading about the Gamestop trading debacle. It’s a wonderful thing when something like this happens on such a scale that we can see the prejudice and tribalism of Wall Street in its purest form.
Let’s go again over what happened.
Gamestop is game shop of the old school kind. Think brick and mortar and you’d be correct (although probably not all stores were brick). Much like other famous businesses of its age (think Blockbuster) it ran into trouble and had to reorganise.
Wall Street didn’t trust the plan and some big investors (think hedge funds) already started preparing Gamestop’s funeral by what’s called “short selling”
Short selling is a pretty straightforward thing. Technically you borrow shares from another investor for a fee. You sell that in the hope that later you can buy it back cheaper, so that you keep the difference and the partnering investor gets its shares back (and keeps the fee as well). It’s a brilliant scheme in that you yourself don’t have to invest much (just the fee). The potential gain though is limited (a share can’t go less than 0) but the potential loss is compounded in the case you lose the bet: you MUST buy back the share eventually even if it goes up, in which case you lose the difference (which is potentially limitless) as well as the fee, which you still have to pay.
On Reddit some people saw an opportunity.
Between the moment you borrow a share for short selling and the moment you have to buy back (cover), you are “holding” a short position. The sell means you’ve released a share into the market. So people can buy them.
So what if there were enough people to pick up those shares as they are sold at the spot price? Well, with enough demand, the price would go up.
But, you’d say, isn’t that bubblish? Aren’t those investors that come in even slightly later set up for disappointment?
Ah, young padawan, but let’s not forget that the short sellers MUST buy back all those shares so they can be returned. All short positions must be covered. You have a wave of buyers (such as the coordinated “assault” of Redditors) but there will be also another wave of buyers: the short sellers covering their position.
The more short positions there are, the greater the price hike over time.
Of course, there’s a catch. In the words of a great man (Dr. Who): “don’t blink!”. For this to work, the “attackers” must hold fast and wait out the short sellers.
Now, let’s take a step back and look at this from the short sellers point of view.
You’re taking short positions against an old school seller. This makes sense. It’s a pandemic. It’s a digital world. Who buys what Gamestop sells? Restructuring or not, that thing’s going down … eventually. Ok, so you take those short positions and things go the other way. Gamers … they’re passionate and resilient. But still, you’re a hedge fund endowed with billions of dollars and they’re just “dumb money” (as Wall Street people call retailer investors). Get a few friends to short even more shares, release them in the market, it’s bound to drive the price down and spook all those freckled virgins in their gaming chairs. Right?
But the thing is … all they need to do is hold on. With the prices going (momentarily) down, more people can get in and they can coordinate. They know what they want to do. The power of social networking can’t be denied. It’s not like the old days when you’d have to call your broker on the NYSE floor and tell them to buy/sell. All they need to do is just sit back with a phone in hand, same thing they do every day just that now they’re placing market orders.
And you can’t do much except watch your cover costs go up, grinding your billions to dust. And the moment comes, you have to buy back! Prices go up, burning the cash of all the other hedge-friends you brought along. All you can do is get ready to take the calls of all those investors whose money you just lost.
Do this and all that happens is that hedge fund money goes to “the people”. Of course, it’s not meant to last forever. Once short positions dry up, it’s investor vs investor and some people (likely those late to the party) are bound to make a loss of some size. Early adopters though can already see their investment 30x.
But unless Gamestop can make good somehow on restructuring, wolves are going to come back. Without some eventual market potential, what goes up must come down.
Then again, the whole idea is to punish short sellers and this has been happening more and more.
Now though, it looks like some of those apps that went at it to democratise investing (Robinhood, eToro et all) have blocked retail investors from punishing those hedge fund cry babies too much.
It’s a weird day when Alexandria Ocasio Cortez and Ted Cruz agree on something, but this they do agree on: protecting hedge funds against ordinary people is not exactly American.
Unless it’s the most American thing to do.