Currently it’s hard to avoid news about GameStop.
Many people are still wondering what is actually happening to the share price. I’m going to explain everything you need to know about what’s going on.
What is short selling?
Before we dive into what’s happening to the GameStop share price, it’s important to understand how short selling works.
Short selling is when a trader believes that the price of a share will go down.
So what they do is this:
- Borrow shares from a broker at the current price.
- Immediately sell those shares.
- If the price does go down, they re-buy the shares at the lower price.
- The amount the share price drops is how much profit the trader makes.
- The more the price goes down, the bigger the profits.
This is a really risky form of trading. Although companies lose value all the time, if the stock price goes up - this is real squeaky bum time for short-sellers.
A stock can only fall 100% but it can technically rise to an unlimited figure. This means that short-sellers can face potentially huge losses if the stock swings up instead of down.
If a lot of traders are betting that a stock will lose value, this can lead to the perfect conditions for a short squeeze.
What is a short squeeze?
A short squeeze happens when lots of people are betting on a stock’s downfall.
If the price starts heading upwards, these short-sellers may decide to cut their losses. Cutting their losses means buying the shares at higher price. This demand from short-sellers causes the price to keep going up.
Because there are only a limited number of shares available, a snowball effect takes over. More short-sellers try and cut their losses but this only pushes the price higher for other traders trying to close their position.
So what does this have to do with GameStop?
Short squeezes have happened before.
However, this one in particular involving GameStop is pretty unique.
These squeezes are normally caused by big financial institutions and hedge funds. This time, it’s Reddit users.
A message board on Reddit called ‘wallstreetbets’ is made up of heaps of regular retail investors. People on the forum realised that over 140% of GameStop shares had been shorted.
The extra 40% comes from a slightly complicated form of borrowing shares. The main point is that many people on Wall Street have been betting on the downfall of GameStop. Once Reddit users started driving the price up, many traders are getting caught up in the short squeeze and are having to buy back shares at ridiculous prices.
These retail investors are basically holding Wall Street to ransom. The short-selling traders have an obligation to replace the shares that they borrowed. This means that they will be forced to buy GameStop shares, even if the price continues to move around in silly territory.
Because there are only a limited number of shares available, if these Reddit keyboard warriors (said with the utmost respect) hang on to their GME shares and refuse to sell - the price will just keep going higher.
This will obviously come to an end at some point. But the fun thing is, no one knows where the limit will be to this desperate buying from Wall Street traders who have already lost buckets of money.
Buying and selling shares
I thought that I’d comment on this topic because it’s a pretty interesting and unique situation.
However, it’s important to remember some people will make a lot of money from this glitch, but it’s not a way of printing money.