Reddit uses GameStop to fight against hedge funds
Image by Kyle Garrity
by Simon Peterson, staff writer
A few weeks ago, one of the weirdest events in the history of the stock market occurred, with GameStop stock jumping over 200 percent from $96 to a high of around $470, a huge gain considering it had been at $18 at the beginning of January. Similar massive jumps were seen from companies such as Nokia, Blackberry and AMC. Hedge fund managers who had “shorted,” or bet against GameStop going up, have lost an estimated $19 billion in January. Along with this, on Thursday, January 28 we saw Robinhood halt buying on 13 stocks, most notably GameStop.
To understand what caused this massive surge in Gamestop, we should first take a look at the online forum on r/wallstreetbets. The subreddit in the past has been known for its aggressive trading, massive losses and insane gains. So back around September, people on r/wallstreetbets began to realize that GameStop was a rather undervalued stock. There were a few different reasons for this thought. First, Ryan Cohen bought 9 percent worth of GameStop shares and later furthered that to a 12.9 percent stake in the company, which led to him getting a seat on the board. This is important because Ryan Cohen had massive success in ecommerce through Chewy.com, an ecommerce company that competed with the likes of Amazon and Walmart, which he sold for 3 billion dollars, now worth $29 billion. Second, GameStop began to have a massive jump in e-commerce sales in the first quarter, which gave the company a new potential direction. Third, GameStop signed an agreement with Microsoft that would help propel them further with the new console cycle.
On top of realizing how undervalued the stock was, people on r/wallstreetbets realized how over shorted the stock was. They realized that GameStop was being shorted by more than 100 percent, and with all the good news coming out, this would force the hedge funds shorting the company to have to cover their positions, thus causing what is called a short squeeze.
Now to understand what a short squeeze is, you have to first understand how a short works. Basically, when someone thinks that a stock will go down, they can borrow a share from someone else for say $10 and sell it. When the stock goes down to maybe $7, that person can buy the stock back and return it to whoever they borrowed it from. Now if a stock goes up and someone is short, they likely will want to cut losses by closing their short positions. This will cause the price to go up even more, forcing other people who are short on a stock to cover their position, driving the stock up even more and continuing this cycle.
After people on r/wallstreetbets realized how GameStop had upside potential and was heavily shorted, they began to start buying the stock, pushing it to soar from around $17 at the beginning of January to $469 at its height on Jan. 28. The subreddit’s main player was u/DeepF******value, who invested $50k in Gamestop back in September of 2019 and led the charge with an account value that peaked at around $50 million. Along with Gamestop’s other stocks that were heavily shorted that became targets of r/wallstreetbets, most notable being AMC Theaters, Blackberry and Nokia. These stocks were further pushed by hype and extensive news coverage, which helped push r/wallstreetbets from under a million members to now over eight million, making it the most active subreddit.
GameStop was also hyped up by a tweet from Elon Musk. Historically, whatever he tweets can move the price of something massively. On top of this, billionaires like Chamath Palihapitiya, a former Facebook executive, and Mark Cuban showed their support, with Mark Cuban even going on Reddit as of recently for an AMA, or “ask me anything.” Netflix is even already developing a movie to cover what happened.
The hedge funds that were short on these stocks took major losses from the insane short squeeze, most notably Melvin Capital, which lost 53 percent of its hedge fund’s value as of Feb. 1. Over the week of January 24 and even now, there is a wrestling match going on between the people who are holding these “meme” stocks, hedge funds and quite frankly, the media covering this, due to how they attacked the Reddit traders.
Due to the hype these stocks that were being focused on received, they began to get massive volume, meaning lots of buy and sell orders. Supposedly, because of this Robinhood restricted trading on Jan. 28 on specific stocks including GameStop, AMC and the other heavily shorted stocks, which caused the stocks to massively dip. This infuriated many, who pointed to market manipulation, seeing as Robinhood's main customer was the hedge fund Citadel LLC. Now when first interviewed, one of the owners, Vlad Tenev, gave a brief explanation saying that it was a liquidity problem. Later, Tenev was interviewed by Elon Musk and gave a fuller explanation of what was going on. In this explanation, he states the reason for the restriction of trading being due to the National Securities Clearing Corporation requiring Robinhood to put down $3 billion for a deposit, which is more than Robinhood had that was liquidable. With the restriction of these stocks, the deposit requirement for Robinhood went down to $700 million.
What happened with GameStop is very rare and honestly one of the most bizarre things to happen in the stock market, which can only really be compared to the Volkswagen short squeeze. The major difference between them is GameStop was not driven by an institution, but instead individuals on the internet. It also really showed how much power the retail investor really has. This will have a major impact on stock traders' strategies moving forward due to how overall hype from retail investors can largely drive up a stock's share price.