Background
The Game Stop situation has taken the Internet by storm as amateur investors conflict with hedge fund managers’ stock market plans. Game Stop has valued at over $10 billion on Wednesday and its price soared again on Friday.
What’s happening?
The process is defined as a “short squeeze.” In simplified terms, investors place bets against a company, believing the value of the stock will go down, rather than the typical method of investing in a company whose stock, you presume, will go up. (For a more in-depth explanation of short-selling, click here). However, there are enormous risks in short-selling that occur when the price goes up instead of down: exactly what happened this last week.
How did this occur?
The famous “Wall Street Bets” on Reddit is a collaborative forum that allows people to share information, tips, and plans for trading on Wall Street in a more informal way (through memes, tweets, etc). Most of these users are part of a younger generation, ages 18-24, and use Robinhood, an app that allows free trades, because of its convenience. After the news on hedge funds’ plans on shorting GameStop was released, the forum spread messages on investing in the company, the complete opposite of shorting. New York Times lists some of the motivations behind these investors: “Some reason that GameStop’s shares are a good value. Others are just riding the wave. And others want to squeeze Melvin Capital, a hedge fund that was shorting GameStop...“It’s not about money; it’s about sending a message.”
All these reasons are why GameStop’s stock price inflated exponentially overnight. Consequently, as the value of the stock rises from these investments, the same hedge fund managers that betted on the price going down are forced to buy more stocks from GameStop, inevitably raising the price and hurting themselves even more.
What are the effects?
GameStop was not the only struggling stock invested in last week. Companies like AMC Entertainment and BlackBerry have also experienced a rise in stock prices.
Hedge funds lost an enormous amount of money: Melvin Capital “lost 53% on its investments in January” and Point72 “lost nearly 15% this year during the GameStop frenzy.” With powerful hedge funds losing billions of dollars, apps like Robinhood placed restrictions on the trading of GameStop and other stocks due to “significant market volatility.” People were angered by these restrictions: the app was overwhelmed with one-star reviews, influential figures like Alexandria Ocasio-Cortez, Ted Cruz, and Mark Cuban publicly criticized Robinhood, and many members of the Reddit forum threatened to file “class action lawsuits” against the company. AOC describes her displeasure on Twitter, “This is unacceptable. We now need to know more about [Robinhood’s] plan to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit.”
However, the GameStop controversy does not just affect bettors and investors. As hedge funds began to lose large sums of money, they are forced to remove investments from other “solid stocks.” The prices will then deplete, hurting investors that have not bought or sold any shares of GameStop.
So what do you think? Do you agree with Robinhood restricting the buying/selling of shares to support hedge funds? How do you think this GameStop frenzy will end?
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