How Reddit Drove GameStop “To The Moon”

During the last two weeks of January, a massive short squeeze involving stocks such as Gamestop ($GME), AMC Theaters ($AMC), Koss Corporation ($KOSS), and other heavily shorted stocks surged beyond imagination in the stock market. In just one trading week, $GME stock rose by nearly 700%, going from $39.2 to closing at $347.51 on Wednesday, Jan. 27. So, why does a company with decreasing earnings and revenue throughout the past decade blow through their all-time-high prices? Two main reasons: a short squeeze, and a large group of “risky investors” on a subgroup in Reddit known as WallStreetBets.

Short Squeeze:
Investors use a strategy called “shorting” when they believe a company’s stock price will go down. Shorting involves someone borrowing shares of a company, then selling them at the current market price, and waiting for the price to drop in order to buy the shares back and return them to the lender. The money they make is the difference between what they bought it (and sold it) at, and what they were able to return it for. When investors short stocks, the market reacts to these sell orders, and the stock often drops because people are betting against it. Gamestop is not the only stock that is shorted in the market, however, the float (amount of shares readily available in the open market) was shorted by over 114%. How can you have more than 100% of the shares being short? Say, for example, person A wants to short $GME so they borrow shares from their brokerage. They now sell these shares in hopes to buy them back at a lower price. Now, person B comes along and buys up the $GME shares that were sold by person A. The brokerage that person B belongs to is allowed to let other people borrow these shares that person B bought from person A. Therefore, the total short position can be over 100% because the stock is borrowed and sold multiple times. This overleveraged, risky strategy is mostly practiced by large hedge funds with enough collateral and leverage to short as many stocks as they want. Melvin Capital, a hedge fund that had the largest short interest in $GME, lost nearly $4.5 billion in assets during the month of January, a 53% decrease in their capital.

How Does The Squeeze Happen:
When you short a stock, because you borrow it, you are forced to buy back at some point. However, when the market receives these “buy orders” from funds wanting to buy back the stock, the price goes up simply because of an increased demand relative to the supply. The risky part of shorting a stock is when the price increases because your losses are infinite. If the price rises $10 past your sell order, you lose $10 per share. In Gamestop’s case, however, the stock rose hundreds of dollars within a matter of days. Here is where it gets more complicated: when you borrow a stock, you are forced to use leverage because the shares aren’t really yours. When a stock goes up as you short it, you can get a margin call which is the brokerage or bank telling you that you need to deposit more money or sell more of your assets to cover your collateral on your leverage. When $GME shot up hundreds of dollars, hedge funds were forced to buy back their shares at horrible prices because their leverage ran out. Additionally, because funds have to place these buy orders, the price yet again goes up further because of an increase in demand. This is what truly causes a short squeeze.

All those years of High-Frequency Readers front running retail traders, now speed and density of information and retail trading is giving the little guy an edge.

— Mark Cuban

r/wallstreetbets (WSB):
How does a subgroup on Reddit filled with retail investors, many of whom are new to investing, cause a historic short squeeze? It all started with a few Redditors who noticed that $GME was over shorted back in October. A user by the title “r/deepf******value,” along with other GME bulls, spammed the WSB forum with due diligence on why $GME could face a massive short squeeze. This gained a massive following, as users posted pictures of their positions in Gamestop while creating more hype, and fueling more retail investors to buy it. As new users flooded into Wallstreetbets hoping to turn their $1000 savings account into a million, the stock price began to rise and kept on rising. WSB went from a few hundred thousand users in October to over 9 million users in February.

Famous investors and entrepreneurs took to Twitter to showcase their support for WSB and the short squeeze. Mark Cuban, owner of the Dallas Mavericks and entrepreneur wrote, “I got to say I LOVE LOVE what is going on with #wallstreetbets. All those years of High-Frequency Readers front running retail traders, now speed and density of information and retail trading is giving the little guy an edge. Even my 11 yr old traded with them and made $.” Cuban points out that for decades the large hedge funds have been able to use high leveraged, high-frequency trading in order to move the market by small increments to create a profit. Now, everyday Americans have been able to take control of a situation and create a massive profit for themselves. Cuban even created a sub-stream on WSB and took questions from users. Many retail investors are fed up with large funds being able to manipulate the market with high-frequency algorithmic strategies. They wanted a piece of the profit, and therefore banded together and outsmarted the funds.

Tell me what to buy tomorrow and if you convince me I’ll throw a few 100 k’s at it to start. Ride or die.

— Chamath Palihapitiya

Chamath Palihapitiya, CEO of Social Capital Investments and venture capital investor tweeted, “Tell me what to buy tomorrow and if you convince me I’ll throw a few 100 k’s at it to start. Ride or die.” Of course, as the hype of $GME raged throughout social media, the comments convinced Chamath to buy $GME calls. He ended up spending $115,000 on calls, which turned into $500,000 in a matter of days. He donated the profit to the Barstool Fund, a charity that is designated to helping out small businesses.

The $GME squeeze was clearly not just full of poorly educated gamblers on Reddit, as it attracted highly acclaimed investors and entrepreneurs. Even Elon Musk tweeted out his support for WSB and his opinion on why hedge funds should not be allowed to use as much leverage as they currently do to short stocks.

The issue surrounding the short squeeze has more to do with hedge funds using their insane capital to manipulate stock prices than it does with just measling out some profit for retail traders. Users on WSB often criticize Wall Street banks and funds for manipulating stocks, overleveraging securities, and ultimately hurting retail traders. Users had remarks on the 2008 recession which was caused by the big banks using too much leverage and risk. It is inspiring to finally see everyday people achieve massive success in the market that is mostly only seen by massive funds. Congratulations to all traders who made a killing during the $GME pump, and sorry to anyone who bought at the top and is still bag-holding the stock.