The frenzy that is Gamestop’s short squeeze has been unfolding like the story of David and Goliath, sending Wallstreet into a fluster. The saga involves Gamestop company stock whose price rose about 77-fold after subreddit r/WallStreetBets members collaborated their trades, forcing short-sellers to cover their positions, leading to a short squeeze.

gamestop explained
Image by: michael-fortsch (Unsplash)

What is a Short Squeeze?

To get a grip of what a short squeeze is, we first need to understand what shorting a stock means. Shorting involves borrowing shares from a broker and immediately selling them with the hope of repurchasing them later when the share price falls and returning them to the broker. If the share price ends up falling as anticipated, the short seller stands to make a fortune. 

What happens if the share price doesn’t fall but rises instead? Well, the short seller still needs to return the borrowed shares to the broker. They are therefore forced to buy back the shares at a higher price. The rush to buy back to cover losses subsequently puts pressure on the share price prompting it to go even higher. That’s what is referred to as a short squeeze. 

The Opportunity: Gamestop was heavily shorted.

What’s more shocking about Gamestop is that the short sellers were so confident of an impending price drop that they shorted more than 100% of the existing shares. At first, you might think it’s impossible to have more than the available number of shares borrowed for shorting purposes. 

Here’s an example of how this would happen. Let’s say that a company has 100 shares of float available for trading in the market. Person A buys the 100 shares. Person B, a short seller, borrows the shares and immediately sells them to person C. Another short seller, Person D, borrows them and sells them to person E. In this case, the number of shares shorted is 200, where there are only 100 available.

Shorting a stock is risky, but even more dangerous is shorting more stocks than currently exist. 

Here’s where the Gamestop saga gets interesting. Some members of WallStreetBets noticed that more than 100% of Gamestop(GME) shares were shorted. And if the price were to go up, there would be more demand than supply since short-sellers would need to buy back more than 100% of the stock to return them to their owners. Buying and holding the stock as long as possible would sharply drive up the price, allowing them to make lots of money. And that is how the Gamestop frenzy began.

Has Wallstreet been beaten at its own game?

The Gamestop surge bears the characteristics of a pump and dump scheme, where a group of investors collaborate to hype up a held stock to increase its share price and then sell at a profit. It is no secret that Wallstreet investors occasionally engage in such schemes to make huge profits at the expense of small investors. 

Now retail investors on Reddit(WallStreetBets) have realized the power of their unity. They have achieved huge profits the same way Wall Street investors do, simultaneously costing them(Wall Street) billions of dollars in losses. Investors on Wall Street are bewildered and want the SEC(Securities Exchange Commission) to take on WallStreetBets. 

While WallStreetBets conspired to push Gamestop’s share price up, there’s no evidence of fraud since this communication took place in open forums. 

Looking Ahead.

There’s a place for everyone within the trading ecosystem. While short-sellers might look like the ‘bad guys’, their decisions are, more often than not, based on research. They raise red flags whenever they come across poorly managed companies and point out overpriced stocks. 

There is, however, a loophole in the current system that Wall Street, and lately WallStreetBets, can use to manipulate markets. Is it illegal? Not really. There is no law that forbids a group of people from holding the same outlook about a stock. Looking ahead, we’re likely to see intervention by the SEC as a result of pressure from institutions.


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