The price of GameStop (NYSE: GME) grew dramatically over the period of just a few days in late January of this year, as well as a few other securities. At its peak, the stock reached a price of $500 per share, creating a stark contrast between its $17.25 value at the beginning of the year, according to data from Yahoo Finance. This was not due, however, to the release of a highly anticipated game or some other similar innovation from the company itself. This arose because of activity on reddit.
The subreddit r/wallstreetbets includes around 3.8 million members, all who could be classified as casual or “retail” investors. Members of this subreddit looked at the GME and recognized that it was being shorted (expected to depreciate in value) by short sellers.
From this observation came the idea that by buying up the shares available for public purchase, the members of the subreddit can trigger a short squeeze, which ultimately forces the value of the stock up very quickly.
A short squeeze can be triggered when short sellers, investors who borrow stock they don’t have at a high price to sell and later hope to buy the stock back for less than they borrowed it for, are forced to buy back their stocks at higher prices than what they originally sold it for in order to not lose more money.
This is bad news for the short seller, but good news for the stock. The buying back of these positions at high prices forces the stock to even higher prices, which meant high returns for members of the subreddit.
This short squeeze also had negative implications for hedge funds, which offsets risky investments by making counterinvestments that aim to cover the losses potentially incurred by said investments. Losses incurred by American firms exceeded $70B, according to a 2021 article by Reuters.
These large losses, and the way this squeeze came about, sparked the interest of Congress and the international community. “This really the first big case of what is essentially a social media group causing a big move in stock prices,” said Robert Cunningham, adjunct professor in economics here at Alma College.
“The hedge fund industry is very purposefully opaque in how it operates, and really only a relatively small number of people benefit from it. [Retail investors] joined up and made decisions that negatively affected a hedge fund’s profits—[that] is something worth following,” said Cunningham.
Caught in the controversy is Robinhood, a financial services company with an app popular with retail investors. Despite having famously said “let the people trade” in a 2016 tweet, they suspended the trading of GME and up to 13 other securities during the squeeze. Robinhood claimed that it did not have the required collateral to execute the high trade volume, but they also have contracts with hedge funds.
“One of Robinhood’s revenue sources is its ability to sell trading information to hedge funds, so I think Robinhood had to weigh the costs and benefits of executing trades on behalf of retail users, versus the costs and benefits of upsetting its large hedge fund partners,” said Cunningham.
Senator Ted Cruz and House Representative Alexandra Ocasio-Cortez came out in opposition to this move by Robinhood.
“This is unacceptable. We now need to know more about [Robinhood’s] decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit. As a member of the financial services committee, I’d support a hearing if necessary,” said Ocasio-Cortez in a tweet.
There will be a hearing on this matter hosted by the Financial Services Committee in mid-February.
Technology is constantly and consistently changing the world around us. For this reason, “average” citizens can communicate much more freely their ideas and make such things happen.