The GameStop Short Squeeze

Courtesy+of+The+New+York+Times

Courtesy of The New York Times

Daniel Bell ‘22

The financial world has recently been upended by the sudden and unexpected rise of the stock of GameStop, a popular video game retailer from 2000 until the mid 2010’s that has since been in steady decline.

The rise was caused not by some action by GameStop – the company has not become any more profitable by any means – rather this was a coordinated effort by Internet users to artificially inflate the stock, mostly for the purposes of a prank. While the stock has declined in recent days back to semi-normal levels, the “short squeeze” caused a week of chaos on Wall Street, with different groups either making extreme profits or taking extreme losses. 

The surge originated in the Reddit forum r/wallstreetbets, a social site where users could post about all things stock-market related. In this case, posts about hedge funds gained popularity, including a particular hedge fund called Melvin Capital, which was short-selling the stock of the company GameStop. 

GameStop has long held an iconic role in certain sectors of video game internet culture. It’s unclear who first drew attention to the franchise’s stock being short-sold, but evidently it was an iconic enough franchise to draw the attention of a large number of users. Specifically, the internet’s ire was drawn from the fact that a number of large investing entities, like hedge funds, were deliberately short selling GameStop stock, making more money for themselves while simultaneously driving down the price of the iconic stock. Specifically, the Internet forum began targeting the hedge fund Melvin Capital (This seems to have been a random choice; Melvin Capital was not the only hedge fund dabbling in short selling, nor does it appear that they did anything to specifically anger reddit users).

Short selling is a market strategy used on companies who appear to be in decline. An investor borrows a stock from a broker, and then immediately sells it. They then wait a period of time before buying it back and returning it to the broker, with a transaction fee added on. If the company has declined in value as expected, the investor would have sold the stock for more than they bought it for, and thus made a profit. Use this process on a massive scale, and it can become very lucrative. The number of sellers also usually results in the value of that stock going down.  

The risk in the process is that it relies on the assumption that the stock is going to be less valuable when you buy it than it was when you sold it. If the stock rises between you selling and when you need to buy it back for the broker, you will end up paying more to buy it than you sold it for, losing money.

What was unexpected for hedge funds like Melvin Capital was this gaping vulnerability that the period between the borrowing and selling of the stock exposed would actually be exploited, much less by an ad hoc army of amateur small-time investors from reddit.

The term “short squeeze” references buying massive amounts of stock to artificially inflate the price, regardless of the actual value of the company. Calls went out on Internet forums for people to buy as much GameStop  stock as possible, and then not sell it. As such, the near-defunct company suddenly found its stock skyrocketing. The price rose 8000% in six months. The higher the stock climbed, the more attention it gathered, and the more small investors joined the push. At one point GameStop, a video game retailer that peaked in the early 2010’s, was the most traded stock on the planet.

All of the hedge funds that had just sold stock in GameStop counting on the price falling suddenly found themselves having to pay 8000% more than they had sold it for, and the unlucky target of Melvin Capital took massive losses. The push didn’t stop at GameStop. Other heavily shorted stocks like AMC, Nokia and Bed Bath and Beyond, began to be artificially inflated by a coalition of small-time intent users in a speculative frenzy.

Eventually apps like Robinhood, an app which allows people to trade stocks who aren’t multi-millionaires, began shutting off all purchases of GameStop stock over concerns about risk both to the app and its users. That caution may have been well-founded – dozens of individuals lost thousands of dollars when the GameStop stock eventually came crashing down. But the move prompted outrage on the online community over the seeming aggression towards small-time investors for the benefit of massive hedge funds.

The shutdown, combined with the inherently temporary nature of a short squeeze, ultimately resulted in the stock plummeting in value. Those who had sold early made thousands, some even millions of dollars, but many small-time individuals lost significant sums of money. Most hedge funds and other large investors made off with huge amounts in profit from the instability, with the exception again being the unfortunate traders at the beleaguered Melvin Capital. However, this was the first time a popular movement had banded together to create so much chaos by exploiting the technical quirks of the market, regardless of the company’s value. A gaggle of amateur reddit users created so much havoc that the US government was forced to take notice. Many wonder whether this will go down in history as nothing more than an amusing sideshow—which seems at present to be the likely outcome—or as an event foreshadowing a new era in the stock market.