There are many lessons involved in this saga so let’s dive. GameStop is the largest physical store retailer selling video games in the US. In recent years the company has been suffering from declining sales and collapsing profits as players opt to buy games directly online through the PS and Xbox stores. It ticks all the boxes of a company that is in structural decline and headed for bankruptcy. Short selling is a way to profit from a stock price falling. To do this, the short-seller has to borrow the shares from someone who owns them. If the stock price falls, the short-seller then sells the shares back to the owner and profits from the difference. However, if the stock price rises, the short-seller has to pay the owner the difference. GS was heavily shorted as many financial pros saw that the stock was headed to zero. A Reddit group (dubbed WSB) decided to start buying GS, and this made the stock rise, meaning the short-sellers had to pay the owners of the shares money in order to keep borrowing them so they could keep shorting the stock. If the stock rises enough, the short-seller eventually has to ‘hedge their bets’ by actually buying the stock themselves. What happened here is that WSB buying GameStop stock sent the stock so high that these short-sellers were forced to buy the stock themselves to hedge their bets, and that made the stock rise higher, which meant the short-sellers had to buy even more stock to hedge, and so on. So what happens is a positive feedback loop that leads to a wild rise in the stock – called a ‘short squeeze’. When you buy a stock, it can only go as low as zero, but as high as infinity. When you short a stock, you’re gaining from the decline – the stock can only decline as far as zero, but can rise to infinity. So the short-seller’s gain is limited, but their losses are infinite. The lesson here – don’t short. Ever. The market can remain irrational more than you can afford to keep your short position, so even if a stock seems wildly expensive, you can get burned. That is exactly what WSB did to the pros who shorted GameStop, and their actions completely obliterated multi-billion-dollar pro firms. Much respect.
Why did WSB do this? Well it appears that the people behind WSB were financially ruined by the GFC in 2008, where the greed of the pros sent the global economy into a meltdown. These pros were never punished for their actions, and so the WSB sought revenge. When the pros short a stock, they release their work to the public, in the hope that they can create enough fear to make the stock fall, and they can profit. It’s a self-fulfilling prophesy. It’s sneaky bs like this that the pros have an unfair advantage over everyone else, and it’s how they stay rich while the world stays poor, even when they destroy the global economy. To their credit what the WSB did was genius, and it worked, and their ability to transfer billions of dollars from these pros into the pockets of everyday people is true Robinhood style. It has been done in the past, with Volkswagen reaching a $500B valuation in 2008 – but in a time when the world’s eyes are on the market, this one is truly memorable. The WSB will likely continue their methods, and while its admirable I couldn’t advise more strongly against following their risky bets (unless it’s play money), as the stock gains are solely a technical factor and have nothing to do with company fundamentals, and so is pure speculation. This type of irrationality is so typical of a bubble, and so again, I’m not saying it’s about to burst, but watch as the irrationality grows because we’re getting ever closer to a bubble that can only burst. However, if you’ve invested in stocks that don’t have absurd valuations, then you’ll be safe to sleep well at night as its the absurdly-valued stocks that tank the hardest and fastest in these situations.
Also, just so you have the whole picture on the Robinhood saga – please note that their decision to limit trading on absurd situations like GameStop actually makes sense. Many of the investors in these situations use their stock portfolio as leverage in order to make these trades. So if GameStop falls 99% (which it very well will eventually), then the stocks you used as collateral won’t be valuable enough to cover your losses, and so the brokerage has to pay the gap themselves. Robinhood just borrowed $1b to cover this issue, it’s hugely expensive stuff when the leverage and risk is so high. So that’s how the situation is from their perspective, they’re essentially trying to avoid going bankrupt. However, they really shouldn’t be calling themselves Robinhood if they aren’t willing to act like one when it matters most to people.
I cannot advise more strongly against being involved in these scenarios – GameStop is sitting on a valuation of $23B, which is 20x more than its value was 5 years ago when it actually had a fundamentally solid business before games could be purchased online. This company is worth $500m at best, and so it will fall eventually, it’s just a matter of when. As the short-sellers stop hunting down GameStop (which they mostly already have), there will no longer be a technical ‘short squeeze’ to keep the stock at current levels, and the bottom will fall out horrendously. Getting involved in this is nothing short of gambling, so if you must take a position keep it as small as you would at a casino (unless you’re a gambler, then please just don’t give into the temptation at all).
