If you’ve been keeping up with the news over the past month, it’s likely that you’ve come across articles talking about the GameStop trading frenzy fuelled by a community of amateur day traders on Reddit, which shot up the share price of the company to stupefying levels and inflicted billions of dollars in losses on Wall Street hedge funds with short positions against the stock.
Now, if you’re not a stock market aficionado, all the jargon and perceived complexity relating to the workings of Wall Street may have been difficult to comprehend. So, here’s a simple and quick explanation of what happened, how, and why.
Let’s start with understanding what GameStop actually is. It is a US-based video games retailer, that in recent years has lost much of its market share due to the proliferation of e-commerce, and whose stock price plummeted from ~$50 a share in 2013 to ~$6 in 2019 due to overwhelming competition from online retailers. The company was expected to close hundreds of stores this year (given the pandemic), and its downward trajectory prompted high-risk investors like some big hedge funds to short its shares and cash in on its misery.
So, what is shorting? It’s essentially a practice that allows an investor to bet that an asset—such as a share—will decline in price, which can lead to tremendous profits if it goes as expected. Short selling involves borrowing shares from a broker and immediately selling them at the current market price, with the promise that you will return the shares later at a specific date. When the price falls, you quickly buy and return the stock back, and pocket the difference.
For example, let’s say an investor wants to short company A, whose stock currently stands at $100 per share. If the price were to fall to $70, the short seller would pocket $30 when purchasing the stock again to return to the original owner. If the company were to go under, the short seller would pocket the full $100 per share. Unsurprisingly, it’s a risky game to play. If you win, you can win big, but if the stock price rises instead of falling, you can lose big too.
This is exactly what’s happening with GameStop. Some eagle-eyed members of the Reddit forum r/WallStreetBets noticed hedge funds betting heavily against the company and decided to buy GameStop shares en masse (which, as word got out, prompted others to do the same), which led to a meteoric rise in its share prices, increasing by almost 400% in just one week and by more than 1600% over the month. The surge led to what is known as a “short squeeze”, forcing short sellers to buy back the borrowed shares at a higher price, which itself pushed the stock price higher. As a result, big investors incurred humongous losses, with one hedge fund, Melvin Capital Management, even being forced to seek a $2.7bn rescue package.
The strategy of buying up stocks of companies like GameStop, is, of course, laden with risk. The price of the stocks being traded is now above any level justified by revenue, earnings, or future prospects (in short, it is completely disconnected from reality). This means, when the market eventually and inevitably corrects itself, the stocks could collapse. This nose-dive is already underway, with GameStop’s market value dwindling by nearly $26bn from last week. However, this has not affected the will of ordinary investors who have borne the brunt of multiple financial crises and continue to face the harsh economic fallout of the Covid-19 pandemic to stick it to the uber-rich Wall Street pundits, who have only grown wealthier in this period of turmoil. It’s worth noting here that it’s a reasonable guess that these investors are not a monolith and that algorithmic traders and other sophisticated institutional investors have most likely joined in the mayhem as well to make money from the frenzy.
“There’s a catharsis to actually making money off their pain a little bit,” Justin Speak, an evangelical pastor in California told The New York Times when asked about his modest earnings from GameStop. Expressing frustration at how those in the financial sector were left seemingly unscathed by the 2008 financial crisis, his wife said, more curtly: “Eat the rich.” And this sentiment has reverberated across individual traders and investors who are often derided as “dumb money” on Wall Street, destined to lose against the sophisticated specialists who do this for a living. Now, it’s payback time, and they’re not just stopping at GameStop, but also turning their attention to other companies that could be short targets this year, such as AMC, American Airlines, Blackberry, and Nokia, among others.
Adding fuel to the fire is the reaction to this debacle by popular (and easy to access) trading platforms like Robinhood, who suspended the trading of stocks targeted by r/WallStreetBets last week citing market volatility. Users were able to sell their existing holdings but could not buy any more shares. The move sparked outrage among day traders and politicians alike, who shared their grievances about the absurdity of the stock market and the reach of corporate privilege.
Though many other platforms took similar steps, Robinhood, whose self-stated mission is to democratise finance, attracted the most ire, getting nearly 100,000 bad reviews, which caused the app’s ratings to plunge drastically. This was later remedied by Google, who deleted the negative reviews overnight, arguing that it had policies against “coordinated and inorganic reviews”. Robinhood is also facing a class-action lawsuit alleging that in restricting trading of certain stocks, it sought to “manipulate the market for the benefit of people and financial institutions who were not Robinhood customers.” The company has since then raised $3.4bn in emergency funding to stabilise its operations and has restored access to the stocks, with plenty of limitations still in place.
While some are challenging the legality of r/WallStreetBets members working in coordination to drive up GameStop shares, experts are doubtful that there is much of a case for that. However, lawmakers like Sen. Elizabeth Warren have called on the Securities and Exchange Commission (SEC), which has already said that it is monitoring stock market volatility, to conduct a thorough investigation into the matter to conclusively understand who the main players are, and whether “there’s big money on both sides.”
She told CNN, “Understand: What’s happening with GameStop is just a reminder of what’s been going on on Wall Street now for years, and years and years. It’s a rigged game… The truth is the hedge funds, many of the giant corporations love the fact that markets are not efficient. They love being able to manipulate these markets because they get better returns and individual investors lose out…We need a market that is transparent, that is level, and open to individual investors. It’s time for the SEC to get off their duffs and do their jobs.”
Despite all the talk of citizen empowerment, class resentment, and standing up to Wall Street, whether this will be a moment of reckoning and the beginning of a new age remains to be seen. People have for years pointed out the unequal power distribution in the stock market, and the fact that Melvin Capital has already received its bailout from billionaire investors, only shows that the big wigs always have and will continue to take care of each other and come out strong and relatively unhurt, a luxury everyday investors do not have.
However, the fact that a group of amateur investors was able to take on the big players in the first place has crushed the illusion of the exclusiveness and untouchability of Wall Street, encouraging everyday people to explore and get more involved in investing. While that is a welcome development that could serve as a check or balance against other large forces (like hedge funds, who are used to throwing their weight around without the fear of consequences) in the long run, better financial literacy will be crucial to educate novice investors about the risks of bubbles and overzealous trading.
The GameStop Mania, Explained
The trading frenzy has pushed up share prices of the company by nearly 1,625% this year, inflicting billions of dollars in losses on Wall Street hedge funds with short positions against the stock.
February 3, 2021
SOURCE: REUTERS