Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Wednesday, January 27, 2021

A Short Story about GameStop

The stock market is an auction house where companies raise money from investors who profit from their growth. Companies rely on stock exchanges to keep an orderly flow of information, money and trades to encourage maximum participation. Most days in the market are smooth, everyone reads the news, makes their decisions and buyers and sellers meet amicably to trade. But every so often comes a day in the market where that order breaks down to extravagant results. 

Today is one of those extravagant days. 

Investors can wager that a company will do well in the future, buying the stock and hoping to sell when the price increases. This is called being “long” a stock. Investors can also make the opposite wager, borrowing the stock to sell it in the hopes that they can buy it back for less later. This is called being “short” a stock.

Enter GameStop (ticker: GME).

GameStop is a retailer, often located in malls, that sells mostly new and used video games. It's sales, profit and stock price have been declining for years. With mall traffic dropping to practically zero last year, things weren’t looking good for the company. Some online analysts held out hope and bought the stock. On the other side of the trade, some hedge funds saw the company going out of business and went short - betting against the stock in a big way.

As market participation gets more social, a huge online community of investors took offense at how aggressively hedge funds had bet against the company. They started buying.

Tuesday, January 12th was a mild day for GameStop. The stock opened at $19.96, traded between $19.32 and $20.40 all day, closing at $19.95. Over the next several days, a flood of buyers pushed the price up to $65. With the price rising so fast, those who were short the stock had to back out of their trade: they were forced to buy shares and the stock price leapt to $150. For those betting on the stock’s demise was enough to wipe out their accounts.

Not only did the short sellers have to buy back the stock at ever higher prices, they had to sell other stocks they owned, causing other major stocks to decline temporarily.

Is this the end? Maybe. Reports are that most of these trades have been wound down. Many brokerages restricted trading in GameStop today, and as they allow trading to resume, I would expect some dislocations. As the recent buyers lose interest, the price fo GameStop will decline, possibly quickly.

Interested in more? Read about the Volkswagen short squeeze of 2008 or Matt Levine’s writing about GameStop Today, Yesterday or the day before!