Originally created in 1984 and renamed in 1999, GameStop is the world’s largest video game retailer. This American high street retail shop sells games, consoles and various other electronics. However, in the mid-late 2010’s, the company profits significantly declined as a result of increased online video game sales, GameStop’s failure to invest in smartphone retail, and the effects of the 2020 coronavirus pandemic. This disappointing performance valued the company shares in April 2020, at $3.25 (£2.38).
Yet the following year, within days, GameStop shares had rocketed from $96.80 (£70.83) on Tuesday (January 26th, 2021), to an astounding $492.02 (£358.44) on Thursday (January 28th, 2021) – an incredible increase of 408%, and an increase of 15,039% since April 2020.
So how did this happen?
Speculators make money from the markets by buying assets such as stocks, shares, commodities, and currencies etc., at a low price and selling them at a higher price. The difference minus commissions is the profit.
This is achieved in two ways: long trading and short trading. The terms ‘long’ and ‘short’ trading have nothing to do with distance; they are simply names of their respective strategies.
A long trade involves buying an asset such as shares, at a low price in anticipation that the price will increase, and selling the asset later on to make a profit. However, if the market price decreases, the trade will lose money.
A short trade takes profit in the expectation that the market price will fall. To achieve this, the trader borrows shares that he does not own, selling them at a high price, in the anticipation of buying the shares back at a lower price, to give back to the lender. The difference between the two price levels minus commissions is the profit gained.
If as anticipated the share price decreases, the short trade yields a profit. However, if the share price increases, it loses money – and the investor will still have to buy back the shares at the higher price, to return to the lender.
Sometimes there simply are not enough shares available to buy back and cover the short trade. It is even possible that more shares were sold than are available in the market, because the same shares can be sold several times over. Consequently, the short-sellers are forced to buy back whatever shares they can at inflated prices. This can cause the share price to rocket to astronomical heights, creating a feeding frenzy of frenetic buying, forcing the price even higher. This is called a ‘short squeeze’.
The losses of long trades are limited only to the original investment. Therefore, only trade money that you can afford to lose. Conversely, the potential losses incurred in short trading can be infinite, and such trades are considerably riskier.
A popular investment strategy of hedge funds is to short low-value shares of struggling companies, in the anticipation that their shares will devalue even further as the companies fail and go bankrupt. Such activities of large corporations add further downward pressure on struggling companies making them more likely to fail, enabling the hedge funds to reap profits. Furthermore, such corporations are also known to compound this problem by publishing statements to convince investors that the targeted company is about to go bankrupt, creating a self-fulfilling prophesy.
A recent phenomenon that has appeared on the market are armies of small amateur investor activists who swap tips and trade stocks based on recommendations shared over social media. One such forum is WallStreetBets of the chat forum Reddit, currently with over six million members, enabling this social media forum astonishing buying power. They recently bought shares in companies such as GameStop, the cinema chain AMC, and American Airlines.
In mid-2020, GameStop was overpriced and several hedge funds shorted the shares, with the intention of forcing the share price down and taking profits.
Subsequently, huge numbers of WallStreetBets Reddit amateur investors bought GameStop shares long, forcing the share value to rally to stratospheric heights. Overnight, the hedge funds lost an estimated $20 billion. This forced a short squeeze. The hedge funds went into a frenzy of panic-buying as they tried in vain to recover their losses, forcing GameStop shares to rally even higher.
The hedge funds had been beaten at their own game.
The amateur long trading activists now have the advantage of selling their shares at heavily inflated prices. While they hang onto them, the hedge funds are forced into paying whatever higher prices the market dictates. The long traders therefore can make huge profits, but the opportunity will not last forever. GameStop is heavily overpriced and when investors start to sell, the share price will fall dramatically. If the hedge funds can afford to, patience before buying may be their best strategy.
Has any illegal market manipulation taken place? This is a very difficult question to answer. No doubt, the US Securities Exchange Commission (SEC) will conduct a thorough investigation to find out, but this will take time.
Some people claim that the WallStreetBets Reddit forum is a conspiracy. Yet, this is a laughable allegation: what are hedge funds if they are not a conspiracy?
There may possibly be prosecutions and possibly further regulation, but this can be tricky. Who should be prosecuted and who or what needs to be regulated: the person who originally suggested buying the shares… the individual investors… the social platform provider?
We may possibly be witnessing the arrival of a new kind of trader, that exchanges ideas and swaps investing tips online, to collude in the purchase of large volumes of shares for a single company. However, such shares are extremely volatile and such a strategy is very risky.
Yet, many of these amateur traders simply did it for a laugh. Unlike the hedge funds whose short trade risks can be unlimited, long trades are limited to the risk of the original investment. Therefore, an amateur investor need only invest a sum that he can comfortably afford to lose.