A year ago, you could buy a share (tiny fractions of ownership in companies that are traded on the stock market) of GameStop for around $3-4. The company was viewed as a dying brick-and-mortar video game store with terrible financial prospects, and bankruptcy was a real possibility. Even before COVID-19, Amazon Prime and other online retailers were simply outstripping GameStop, thanks to the sheer ease of use. Despite this fall from grace, on January 28th of this year, GameStop hit its all-time high of $483 a share, despite little change in its financial situation. Since then, the stock has tumbled into the roughly $40 a share range, leaving many who bought late with big losses. What exactly happened to generate these wild results?
What do I need to know?
Most importantly, you need to have an idea of what a ‘short’ is. Essentially, a short position is nothing more than a bet that the price of shares in a company will fall. This is done by the shorter (usually a large investment fund, as shorting can be very expensive) borrowing the shares from another fund and selling them immediately, with the aim of buying the shares back at a lower price and returning them to the lender, pocketing the difference as profit. With a seemingly dying company such as GameStop, many large funds viewed taking a short position as a way to make some easy money.
The key thing to note is that if the price of a share rises, the shorter will still eventually have to buy the shares at whatever their new value is and return them to the lender. Another important thing to note is that many professional firms now use algorithms in a lot of their trading, meaning that shares hitting certain prices or having a certain amount of momentum can trigger a lot of automatic purchases. Suppose a stock that has been shorted rises too much. In that case, shorters are likely to automatically repurchase shares that they owe to the lender before things get out of hand in order to cover their potential losses from any further rises. With large investment funds, this is often millions of shares being bought to cover their losses, so the momentum generated from such large purchasing volume could dramatically raise the price further- what could possibly go wrong?
The Run Up
Although much of the GameStop story drama took place in the space of a few days, the vital background began to take place in late 2019/early 2020, right when the stock was near its lowest. Value investors such as Keith Gill, who is now involved in a United States congressional hearing on the matter, believed that GameStop was fundamentally undervalued at these depressed prices. He believed that the release of the next generation of gaming consoles such as the PS5 would drive a rebound in the GameStop stock price. Likewise, Michael Burry (the guy from The Big Short) had acquired a significant position in the company in late 2019, with the view that an increase to a price of $10-15 was on the cards, netting gains of over 100% for those who got in early. Momentum in the stock picked up in September 2020, when Chewy founder Ryan Cohen purchased a 10% stake in the company, driving the stock into the $10-20 range until mid-January 2021.
At the same time, hedge funds such as Melvin Capital had been building short positions against the company, betting that the stock price would eventually tumble. Over time, the total number of shorted shares actually ended up outnumbering the total number of shares available to trade. The reason this sounds so ridiculous is because it is; shorters were so confident that GameStop would go bankrupt that they started to lend shares that had already been borrowed. The act of lending shares to shorters that you don’t own is illegal, but the loophole of lending those that had been borrowed laid the foundations for an enormous price rise. This could be triggered if hedge funds were forced to buy shares of GameStop to cover their losses against their shorting, with the massive influx of buying activity likely to drive prices up as hedge funds struggled to buy shares that there simply weren’t enough of, at seriously inflated prices. Different hedge funds likely covered at different price points on the way up, fuelling the rally and creating a positive feedback loop as individual investors began to realise what was happening.
As Gill posted updates to popular Reddit trading forum WallStreetBets, doubt began to turn to FOMO as more members piled on. This, combined with hedge funds covering, drove much of the initial rally to a high of $145 a share on January 26th. At this point, those who picked up shares only a month ago had seen a return of over 1000%, and the total value of Gill’s position had turned from $770,000 to a cool $17,000,000.
The peak of Gill’s (publicly disclosed gains), sourced from his Reddit account
After the market closed on January 26th, things really started to take off. A simple Elon Musk tweet, “Gamestonk!!”, with a link to WallStreetBets attached, sent the stock flying the next day. At this point, the forum was home to around 2 million members. Two days later, the count had increased to 5 million, and now sits at over 9 million. The massive influx of first-time investors jumping on the bandwagon was the primary factor in continuing the rally as GameStop began to garner international attention.
By this point, many who were getting involved were doing so as a seeming rebellion against Wall Street. Gill’s position measured an eye-watering $50,000,000+ as of January 28th, and many fresh investors were beginning to pledge that they would not sell until he did first. Others were projecting a price of over $1000 dollars a share, and several celebrities were pledging their support. Combined, these factors seemed to signal that things would begin to go very wrong, very quickly, and indeed they did.
A loss of over 10 million dollars from user u/lantern_fan, as of January 29th
January 28th was the beginning of the end. Due to liquidity and order processing issues caused by the sheer number of investors trying to buy GameStop, several brokers implemented bans on purchasing the stock (and a few others, such as AMD, which had been caught up in the hype), whilst still giving customers the option to sell. This triggered a dramatic drop from the high of $483, right down to $126 in just over an hour.
This was followed by a total reversal, with the stock topping $400 a share the very next day, presumably driven by the last of the hedge funds covering, as individual investors continued to be denied the ability to buy. These jarring swings, the inability of regular investors to buy, and the lack of hedge fund support behind the stock spelt incoming disaster. Since then, the stock has lost value almost every day, leaving the vast majority of those who didn’t sell deeply in the red.
Gill made out with at least $13,000,000 total, so no complaints there. Nonetheless, the GameStop fiasco shows the importance of resisting the urge to FOMO into speculative investments and the importance of not becoming emotionally invested. There have been many horror stories reported of usually-safe investors getting caught up in the hype, and there are surely plenty of massive undisclosed losses. Browsing the WallStreetBets forum, losses range from students who lost their loans right up to losses of literally millions of pounds. Unfortunately, ‘get rich quick’ schemes don’t work out for everyone.