Game Stop stock (GME) has been in the news a ton lately due to a war raging between retail investors and institutions. This post will explain why the war chose Game Stop and what exactly is going on. While it might seem very technical, it’s actually simple and straightforward.
Game Stop Company
Before I dive into the current situation, you need to understand some of the background. Game Stop is a retail brick and motor store that sells video games. The bread and butter of the business were the trade-in games and used games. That represented about two-thirds of all their sales.
They survived because a gamer could buy the disk for $60 and then, after playing it, trade it back in for $30, making it only cost $30 for the game.
Video game manufacturers have taken note and are moving the industry to a digital platform that is killing the used game market. Since there are no disks, games cannot be traded in. This shift has started a slow decline of Game Stop, which began back in 2015.
Recently, with the pandemic, Game Stop was in trouble with debt and very few customers. This created an opportunity to profit from their hardship, enter the hedge funds.
The same thing that happened to blockbuster is happening to Game Stop but instead of movies, it’s video games! Thus the current market rally is more about screwing wall street funds and making money off of them.
Shorting a Stock
When hedge funds or anyone believes a company is in trouble, they can short the stock. Shorting a stock is borrowing shares of stock from a broker and then selling those shares. When the price drops, you repurchase the stock at a lower price and split the profit with the broker who lent you the stock.
Unlike traditional investing, Shorting is selling high and buying low. While this seems simple, the risk is considerable. If the stock rises instead of falls, you could have to repurchase the stock at a higher price!
Game Stop War
WallstreetBets (WSB) is a Reddit forum that over 2 million retail investors that debate different investment ideas. They usually focus on high risk and high reward investments.
Some of the members noticed in December 2020 that Game Stop had over 100% short interest. That means that more people were shorting the stock than there was stock available. This created an opportunity to force a “short squeeze.”
A short squeeze is when a person or fund shorting a stock is forced to repurchase the stock as they have expiration dates. As the dates approach, the stock could rally from the stock volume being bought to cover the short.
Well, the WSB crew has been targeting these situations and drive the stock prices up by buying the stock. Since there is over 100% short interest, the stock price will rise fast. This forces the funds to buy back the stock at high prices, thus losing billions.
GME was around $15 in December and rose to almost $350 at one point. For the WSB crew, a $1,000 invested in December would have become $23,350 this week. Not bad for a month. On the other hand, the funds would be losing the same amount per thousand invested plus fees to the broker they loaned the shares from.
GME stock is worth somewhere between $9-12 based on the actual business. The stock is skyrocketing as there is a shortage of stock available for the funds shorting to buyback thus driving the price up. Basically, this rise in stock has nothing to do with the company but all to do with how a bet can go wrong and that the fund will be forced to buy back millions of shares regardless of the stock price.
Legal and Fair?
There have been many questions around whether it is legal for people to post on an online forum to short a stock and what each person is doing? Funny how when wall street big boys are losing, it’s not fair! Anyway, I am not a lawyer, but from what I read, it is legal.
Cheering on stock and encouraging others to follow your investment is pretty much like what TV stock analysis does. Since there are no agreements, and the swings are individual decisions, it’s legal. This adds the risk that if the crowd were to lose interest, it would all crash.
Not Easy to Beat Wall Street
So if you think the giant hedge fund that was targeted here took its losses and moved on, you would be wrong. They got a loan and doubled down. About the same time, the WSB forum had all kinds of paid ads promoting other stocks that would make a killing, and fake accounts appeared to agree with the ads. The goal was to divert investments away from GME. This attempt failed.
Next, the Brokerage firms started to have outages due to volume and put restrictions on the GME stock. Last but not least, the WSB forum was taken down for profanity and hateful language. WSB is back online as you can stop 2.2 million people. The stock has dropped a little but the retail investors are holding strong against the hedge funds!
I can assure you that the language in WSB was not G rated, but it was not directed against anyone other than Wall Street. The Hedge fund did everything it could to break confidence in the retail investors, which would trigger a selloff.
Most retail investors have stop-loss orders which will sell their shares if it drops below a specific price. Funds know this and try to get it low enough to trigger this, which is enough to crash a stock. Always trying to make a buck against “dumb money.”
Rise of the Retail investors
Over and over, retail investors have been called dumb money and put down, but with all the data the big firms use at retail investors’ fingertips, the tables are turning. WSB, with almost 2.2 million followers, is a force that can take down hedge funds. As shown with game stop, WSB has power! If each member of WSB invests $1,000 into a stock, that will drive 2.2 billion, which is a lot of firepower!
What makes WSB even more frightening to hedge funds? They have been targeting specific stocks and making a killing. Many of the investors take the YOLO (you only live once) approach and are investing not $1,000 but $500,000 plus that they have gotten from other crazy bets. This is putting the firepower of WSB closer to one of the top 20 funds if it was a fund.
The SEC is monitoring the situation but has not put any guidance on if this will be stopped in the future.
Do I wish I could make $22,000 in a month? Of course, but is there a ton of risk, YES! I may goof around with a small amount in the future, but I would never put all my eggs into one basket. Fear of missing out also drives these rallies of people chasing the money. I highly recommend again chasing the money!
If you want to know more about my investments and get a feel for my investment style, check out my January Portfolio update!
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