In something out of a Hollywood comedy, a bunch of kids on an online forum made fools out of billionaire hedge funds. The case of GameStop and Wall Street has been impossible to avoid, as this David and Goliath tale has captivated the hearts and minds (and wallets) of investors everywhere. But why is everyone talking about it on cable news and social media? Let’s take a ride “to the moon” and learn more about this riveting story in the stock market.
GameStop vs. Wall Street: A Primer
In January, GameStop shares skyrocketed more than 1,600% to a little more than $300. The stock had been trading at a 52-week low of $2.57, with market signals suggesting that the stock was on life support. It looked like hedge funds were going to add to their bottom line on the trade, but then Wall Street Bets, a Reddit forum that turned into a decentralized hedge fund overnight, entered the equation and brought these institutional investors to their knees.
An army of Redditors, known for their memes and massive losses over the years, poured into the heavily shorted stock and forced a short squeeze. A short squeeze is when a stock rallies and forces investors, who bet that the asset would decline, to purchase additional shares to avoid higher losses. There was upward pressure on the stock’s price during the GameStop frenzy, making people a lot of money.
Trading platforms, like Robinhood, TD Ameritrade, and Charles Schwab, intervened and placed restrictions on buying these stocks. This sparked questions about the legality and ethics behind the decision, but these companies stated that they were trying to protect their customers. U.S. government officials have promised to hold hearings and launch investigations.
A Brief History of Short Squeezes
Is this the first time that a short squeeze has happened before? No, and one of these occurred about a year ago, although it was not as epic. Well, maybe for Elon Musk.
Musk’s Tesla Motors had faced monumental shorts since 2019, only for the company’s shares to surge about 1,000% in 2020. But short sellers are hanging onto their positions, continually thinking that the Tesla stock will tank anytime now. Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, may have summarized this investment strategy by calling the shorts “by far the longest unprofitable shorts I’ve ever seen.” Musk celebrated by selling “short shorts.”
Volkswagen is another automobile company that beat the shorts. The German carmaker had faced enormous bearish positions from hedge funds after reports that it was in the process of being purchased by Porsche. In the end, Volkswagen had become one of the most lucrative brands in the world, and VW shares had surged to about $1,000 a share. Hedge funds lost approximately $30 billion on the bet.
A Future of Short Squeezes?
Now that armchair investors have memeified the stock market, will this mean that the equities arena will regularly witness something like GameStop?
With GameStop, Wall Street was blindsided by what transpired. The hedge funds were not prepared for it. The power players on the New York Stock Exchange are now ready for the Reddit army. They are possibly reconfiguring their bullish and bearish positions on a diverse array of investments. A short squeeze will unfold again – it is inevitable, but GameStop’s immense volatility will be hard to rival.
How Social Media Has Forever Changed Things
Social media influencers can boost sales for sneakers, sodas, and scarves. So, why not stocks?
Thanks to the rise of free and convenient trading outlets, such as Robinhood, a new generation of investors has been born. In the fallout of the coronavirus-induced market meltdown in March 2020, young investors, many of whom had been priced out of stocks due to their tremendous growth since the Great Recession plunged headfirst into equities. At the same time, they changed the way the game is played utilizing social media to their advantage.
The entire financial market is no longer confined to 60-year-old professionals sitting in opulent offices pouring through hundreds of documents with fine print and industry jargon. The broader market may care if financial analysts are releasing “buy,” “sell,” or “hold” ratings for tickers. Not so much for the new class of eager investors who have felt left behind in the wake of the 2008-2009 economic collapse.
Musk added “#bitcoin” to his profile and the value of the cryptocurrency skyrocketed 20% almost immediately. One of the top Twitter trends is “#silvershortsqueeze.” Dogecoin, a relic of the early days of cryptocurrency that was born from a meme, has been rejuvenated because of social media. Will hedge funds adapt to the changing times? They may need to if they hope to stay relevant.
The Federal Reserve Casino
If there is one constant variant in this entire saga, it is the Federal Reserve System. Thanks to the U.S. central bank’s zero-interest-rate-policy (ZIRP) and the trillions that have been pumped into the financial system, this type of trading activity has trickled down to traders buying and selling stocks from the comfort of their homes. Out with the hedge funds and in with the memes? Either way, the Fed will continually play a significant role in U.S. stocks’ volatility and price action for many more years to come.