An obscure Reddit forum, a failing games shop, and a saga that could end up costing Wall Street billions – welcome to the bizarre trading scheme that is shaking up stock markets across the world.
Gangs of armchair investors, using a page called Wallstreetbets to organise, have been roving the internet in recent days – buying up failing stocks in order to hurt predatory investors, with only half a thought to making money in the process.
It involves taking advantage of a process called ‘short selling’, which effectively reverses the way the stock market traditionally works.
Instead of buying a stock in the hope company does well and the price goes up, then selling for a profit, shorting involves betting against a stock in the hope the value goes down, and then pocketing a share of the difference.
The catch is that, if the investors are wrong and the price actually goes up, they will end up losing potentially huge sums of money, depending on how far the price rises.
Amateur investors organising around a Reddit page called Wallstreetbets have sent failing shares in companies around the world soaring after pulling off a similar stunt with GameStop
Shares include theatre owners AMC (seen above) which is swinging wildly today as amateur investors went in search of unloved shares to buy, and hedge funds to hurt
Blackberry was also among the companies targeted
Phone-maker Nokia was also among companies whose stocks were caught up in the furore
American homewares store Bed, Bath & Beyond has also seen its stocks hit
The current trend began when one eagle-eyed Redditor noticed that investors had placed very hefty bets against games retailer GameStop.
Using cheap trading platforms such as Robinhood, Redditors then began buying up the stock, driving the price up while knowing that in order to cash-out their bet, investors would have to bump up the price further.
That would mean the initial Reddit investors made a profit, while simultaneously inflicting losses on the investors.
How does ‘shorting’ a stock actually work?
Stocks typically benefit investors if the price goes up – they buy stock, the price increases if the company does well, then they sell it for a profit.
But there is a way to reverse that process. Known as ‘shorting’, it involves placing a bet against a company that means a trader makes money when the value goes down.
To do this, a trader borrows stock off a broker, usually for a fee, which they immediately sell – but with a clause saying that they have to buy back that stock by a certain date and return it to the broker.
If the value of the stock goes down, then the trader buys it back for less than the sale price, returning the stock to the broker along with the fee and keeping the rest of the money for themselves.
But, if the stock price rises, they will be forced to buy for more than the sale price, making a loss in the process.
While this sometimes happens by accident, other traders can deliberately boost the price in a process known as a ‘short squeeze’ – which is what Reddit did.
This benefits the ‘squeezers’ because they know that at some point, the short-sellers will be legally obliged to buy back their borrowed stocks, driving the price up further.
It also inflicts heavy losses on the short-sellers, since the amount they lose is tied to the amount the stock rises – they are effectively ‘punished’ for betting against the company, which is what some Redditors appear to be interested in.
As the hedge fund’s losses began piling up, vindictive investors then began pouring even more cash into GameStop, seemingly with no other intention other than to hurt Wall Street and one fund in particular, named Melvin Capital.
At one point Elon Musk – himself no fan of short-selling investors – doubled the price of the stock with a one-word tweet that read simply: ‘Gamestonk’.
Since then, stocks in other companies with hefty bets placed against them have also begun trading upwards – from the likes of cinema chain Cineworld, to phone-makers Nokia and Blackberry, and US homewares store Bed, Bath & Beyond as Reddit hunts for new victims and investors try to second-guess their next moves.
Many of the companies have links to Melvin Capital, the fund which was the initial target – including the likes of Polish games maker CD Projekt Red, and German firms Evotec, a drug-maker, and Varta, a battery manufacturer.
Mining company GME Resources Ltd also saw a brief rally in an apparent case of mistaken identity: It trades under the initials GME on the Australian Stock Exchange which are the same initials used by GameStop when it trades on the New York Stock Exchange.
Day traders as far afield as India and China are also joining in the race, attempting to guess where the money is heading next, according to Yahoo Finance.
GameStop itself has seen shares rise more than 1,500% in value so-far this year, currently sitting north of $300 per share.
While that has meant huge paydays for some of the early shareholders – its three largest have made some $2billion since it all began – a crash is inevitable.
The loss-making retailer has been struggling badly in an increasingly online world, with the pandemic accelerating the decline.
Since nothing has changed about the business to cause share to soar, they will fall back in with market expectations sooner or later.
Ironically, that should make it a perfect target for the next bunch of short-sellers, one European investor told FT.
In the meantime, hedge funds that bet against GameStop originally have lost at least $5billion, according to Business Insider, thought the true amount is thought to be far higher than that.
At least $3billion had been pumped into Melvin Capital to keep it afloat before it was able to withdraw its bet against GameStop, bringing with it ‘huge losses’, the manager of the fund told CNBC.
The extreme volatility has also raised concerns about manipulation which could lead to an investigation by stock market regulators, and has even drawn attention from the White House.
UK cinema chain Cineworld
The company surged 50 per cent in extended trade Tuesday after Musk tweeted ‘Gamestonk!!’ ‘Stonks’ is a tongue-in-cheek term for stocks widely used on social media
The White House and Securities and Exchange Commission said they are monitoring the situation as a growing number of state regulators called it ‘dangerous’.
Wall Street investors are now thought to be sitting on estimated year-to-date losses of $70.87 billion on bets against U.S. companies that have surged in recent weeks.
The gains have forced short-sellers to buy back stock to cover potential losses in what is dubbed a short-squeeze.
Moves were exacerbated by more retail investors piling into the stock.
Ortex data showed that as of Wednesday, there were loss-making short positions on more than 5,000 U.S. firms.
A GameStop storefront is shown before opening Thursday morning in Dallas
Shorting GameStop may have cost $1.03 billion year-to-date, Ortex estimates, while those shorting Bed, Bath & Beyond were looking at a $600 million loss.
The trend of retail traders duelling with hedge funds has rippled out into Europe and Asia.
Heavily shorted Australian shares Webjet and Tassal Group rose more than 5% on Thursday, bucking falls in the broader index.
Retail traders have targeted the most shorted European names including Pearson and Cineworld, although losses are much smaller than in the United States.