Gamestop and Shorting the Market

I don’t know the origin, but this someone was nice enough to turn it into text. I’ve edited the tweet thread somewhat for readability:

I know at least one of my followers doesn’t quite understand what is happening in the stock market right now and that’s enough to motivate me to explain because this is somewhat of a turning point in world history.

First, you need to understand what a ‘short’ is in trading.

A ‘short’ is when you borrow a stock from a broker and sell it immediately at its current price. Then you hope the stock’s price falls such that you can buy the stock back at a lower price and return the shares you borrowed to your broker, but keeping the difference.

Example: Let’s say I want to short XYZ which has a current price of $10. I borrow 1 share and sell it immediately at $10. I have $10 now but I owe my broker the 1 share I borrowed. Then let’s say the price of XYZ drops to $7.

I now decide to ‘cover’ (buy it back) my short position and buy 1 share at $7 and return the 1 borrowed share to my broker. I made $10 when I sold and only had to pay $7 to buy it back lower, so my profit is the $3 difference.

But now let’s say that instead of the XYZ price dropping to $7, it goes up to $15. I still need to return the 1 borrowed share to my broker, except now it’s going to cost me a lot more the buy it back.

If I buy back at $15 so I can return the borrowed shares, my losses will be the $5 difference between selling at $10 and rebuying at $15. Since the price can rise indefinitely, my potential losses as a short seller are unlimited.

At some point I have to buy it back to return the shares I borrowed. The more the price rises, the bigger my losses.

Now for Gamestop. A few weeks ago a redditor on r/WallStreetBets noticed that a hedge fund had taken a massive amount of short trades against Gamestop.

They convinced everyone on the thread to join forces and buy as much Gamestop stock as possible. This made the price rise and the hedge fund’s short position started to lose billions. Their losses even surpassed the 13.1 billion that the hedge fund was worth.

Eventually, the hedge fund had to close their short positions and buy all the Gamestop stock back at much, much higher prices, sending the price even higher still. This is called a ‘short squeeze’.

Now the hedge fund is declaring bankruptcy, and the reddit thread is combing through other hedge funds with massive short exposure so they can short squeeze them into bankruptcy as well.

All of Wall Street is saying that the public joining together in this fashion should be illegal, but really they just lost at their own game to the masses.

I rather like this headline too. How a Bunch of Redditors with $600 Stimulus Checks Outsmarted Wall Street Hedge-Fund Managers

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