The recent astounding upsurge in GameStop stock prices from $4 to $35 a share is both an example of the volatility of the Stock Market and how speculators can “out-speculate” each other. In the latter case, it was all about a practice known as short selling.
Short selling is a strategy that predicts that a stock will decline. The investor begins by borrowing shares of a stock that is likely to lose value by a set future date. The borrower bets that the stock price will continue to decline. Then the investor sells the borrowed shares on the open market to buyers who are willing to pay the full market price. When payment becomes due — i.e., margin calls come in — the trader then pays a lower price and takes a profit on the deal.
To begin short selling, a trader must have a margin account, which requires interest payments on the value of borrowed shares while the “short position” is open. Stock Market regulatory authorities oversee margin accounts and set minimum amounts that must be maintained.
Short selling can offer big profits, but an investor can experience huge losses when the price holds and the original stock seller begins calling in payments. Also, short selling can be especially costly if the seller guesses wrong about the stock’s price movement.
Thus was the case in the recent GameStop debacle. The video game company experienced a modest uptick in its stock value as the demands for their games surged during the Covid-19 pandemic. Then, a group of Wall Street critics on Reddit took this to another level by all agreeing to buy the stock at once. As a community of amateur private investors began buying up the company’s stock, it climbed higher. That surge crushed GameStop short sellers, all mainstream Wall Street establishment denizens.
Smart money in the big hedge fund world was on GameStock’s not holding that position. In fact, it was nearly bankrupt and didn’t have the sales and resilience to withstand Amazon or downloaded games through the enormously popular Play Station and X-Box game consoles.
Other targets of the amateur investors were AMC, whose shares tripled overnight. Other stocks attracting strong amateur attention are Bed Bath & Beyond, Blackberry, and battery maker Plug Power. What all those companies have in common is they have been the prey of aggressive big Wall Street players — Melvin Capital, for one — whose positions include GameStop and AMC.
Stock speculation and day traders seeking fast profits on the stock market is nothing new. The difference nowadays is that retail trader platforms like Robinhood provide much easier access for the small investor. All that amateur activity has pushing many hedge funds towards bankruptcy and seriously worrying Wall Street professionals.
That worry and concern likely resulted in the brokerage app Robinhood barring the purchase of GameStop and AMC shares. Citing a “coordinated effort” from amateur stock traders congregating on Reddit, the site allowed users to close out their positions but shut down buying more stock.
The Robinhood Spokesperson explained, “In light of recent volatility, we are restricting transactions to certain securities to position closing only…We also raised margin requirements for certain securities.”
On the other hand, big hedge fund investors were not subject to that stoppage. That has ignited a controversy that has already raised the hackles of several lawmakers, complaining that the game is rigged for the wealthy.