GameStop, Short-Selling and the Stock Market
Let’s talk about the stock market. Specifically, the absolutely wild ride stocks like GameStop and AMC went on this week, driven primarily by retail traders who are doing what they can to screw over hedge funds and other Wall Street-types.
What I want to do today is explain 1. What the hell is going on 2. How traditional financial institutions are responding and 3. What this means more for the future of the market.
So pretend I’m Margot Robbie in a bubble bath and let me explain the first part: what the hell is going on.
We’ll start with shorts. A short is a type of investment strategy in which one investor borrows a stock from another investor for a small fee, agreeing to return that stock on a certain day. The borrower then goes to the stock market and sells the stock. They’re betting that the stock’s price will go down, so when they have to rebuy the stock to return it to the lender, they can make a profit.
Here’s the problem: Even if the stock’s price doesn’t go down, the borrower still has to return the stock. The potential for loss is technically infinite. If you borrow a $6 stock expecting it to go down to $2, but it instead goes up to $100 by the date you’re due to return the stock, you’ve lost $94 instead of making $4.
There are some investment firms whose entire game is shorting stocks and making money from them. They’re called short-sellers.
As the folks on popular investment forum r/WallStreetBets have realized though, if you continue to push up the price of a stock, no matter what the underlying value is, the short-sellers get screwed. Short-sellers still have to buy the stock so they can deliver it to investors, driving up a stock’s price even further. This is called a short squeeze.
GameStop is a prime example of this phenomenon. Retail investors (aka, little guys like you and me) have been hyping GameStop online, not only because they believe they can make money from the stock, but also because they want to mess with short-sellers. Which honestly? Is kind of rad.
On Thursday, the platforms we use to trade like Robinhood and TD Ameritrade decided to limit retail investors’ ability to buy GameStop and other stocks that have been the subject of social media chatter. NASDAQ, one of the major stock exchanges, signaled Wednesday that it may halt trading on certain stocks if they believe they have been artificially pumped up.
They are technically allowed to do this. The terms and conditions for these sites — which you sign after joining — say these companies have the right to limit your ability to buy certain stocks. Still, customers have already filed lawsuits against some of these companies, and the Senate Banking Committee plans to hold a hearing on the subject.
This, obviously, has the retail investment crowd upset. The argument is that traditional traders, like hedge funds and investment banks, can use their own methods of hyping up stocks like issuing analyst reports with high price targets, taking out activist stakes in companies they believe are underperforming, and even shorting stocks. They also are much more closely tied to organizations like the NASDAQ and even Robinhood, which means they can more easily sway these companies than a regular person.
Some folks on the opposite side have voiced concerns that this could be a pump-and-dump scheme, under which people say positive but false things about a stock they own to get its price to increase, then sell to reap a profit.
But that’s not exactly what’s happening here. The folks on r/WallStreetBets aren’t hyping the GameStop stock because they think it’s valuable. They’re expressly trying to engage in a short squeeze while making a little money along the way.
So is this Occupy Wall Street 2.0? Maybe.
What’s going on has pitted traditional financial elites — the 1%, in Occupy parlance — against the rest of us. There’s a desire to decrease the influence that the rich and powerful have over our lives, and level a more equal playing field. In short, much like Occupy Wall Street, it’s a populist movement.
But the market is so much different now than it was during Occupy. Normal people can trade easily online because they no longer have to pay fees on some trades. The internet is significantly faster. Social networks are more connected.
We are different too. We've been living in this pandemic for nearly a year. During this time, wealthy executives have gotten richer while many folks have lost jobs, drained their savings accounts, and have gotten a measly $1,800 from the government they pay taxes to, all while being told to stay the fuck home. We also just lived through an attempted coup!
I cannot emphasize enough how I think this all has totally changed our brains. People are traumatized, under a ton of pressure, super stimulated by social media, and just generally are, as Dorinda Medley puts it, NOT WELL BITCH.
What I’m wondering about this all is what the end-game will be. Bloomberg columnist Matt Levine suggested a few possibilities in his latest piece. For one, GameStop could use the money to innovate and become a good enough company to justify the high valuations. A second possibility is that this gets taken to the extreme — hedge funds get bankrupted, the stock markets shut down, etc. Both are pretty unlikely, according to Levine.
The third option is that this ends up being a bubble. When it pops, investors — whether they’re hedge funds or regular people — lose out. This is the most likely option: we saw a similar retail investment bubble burst in the early 2000s that scarred a lot of retail investors. I hope that retail traders don’t get screwed, but I honestly think they might.
More broadly, it’s worth considering what this means for the market. In my view, this episode is another piece of evidence that rejects the idea that markets are rational or efficient. I feel like behavioral economics has already pushed back against this idea, but living through this drives that point home. That joke about the stock market being astrology for cis guys comes to mind. I think that investors also now have to factor in this type of behavior when they’re making risk/reward decisions, which is kind of cool.
From a personal finance perspective, here’s what I will say. I cannot advise you on what stocks to buy or not buy. But before you make any decisions, consider 1. Why you’re investing 2. Whether you can afford to take on the risk involved and 3. What would happen to you if you lost all the money you put in the market. The third point is especially important if you’re considering buying a single stock.
If you’re getting into the day trading game, be sure to set aside money for taxes. Any gains you make on your investment will be taxed at your regular rate if you hold the investment for less than a year, and at long-term capital gains rates if you invest for more than a year. Put that money in a high yield savings account and don’t touch it until tax season.
I’m excited to talk with you all about this in the She Spends Facebook group and Discord in the coming days. My guess is that the situation will continue to develop and I — much to my brain’s discontent — will be glued to social media, absorbing all the memes and hot takes.
