Ultimately what happened is that both side of the trade faced a risk, and they each pushed until they hit that risk. The short sellers risked a squeeze by shorting so much of a small stock and the buyers risked crashing their brokerage with their activity. Those risks were always there, they were just so far out there and obscure, nobody counted on them.
What happened here?
Gamestop is a video game retailer that you may recognize from the last time you strolled through a mall. From 2015-2020 their share price declined over 80% as their foot traffic, sales and profit declined. In late 2019, with the stock in the low single digits, stock analyst Keith Gill noticed that, while beaten up, the stock shouldn't be left for dead. Noting that there was significant cash on the balance sheet and a new CEO promising transformation, Gill, who goes by Roaring Kitty on YouTube bought and promoted the stock online and on an investment related page of Reddit. Many of those in Gill's audience were newer investors using the brokerage Robinhood.
On the other side of this trade were people who saw Gamestop's declining fortunes and saw an increasingly dark future for the company. Those investors sold the stock short. We talked briefly about this the other day, as the action was heating up. We are approaching a resolution now.
One particularly weird facet of this story is that the "short interest" in the stock was 140%. Short interest is the percentage of available shares that are "sold short." In this case, there were more shares sold short than shares in existence. How could that be?
To back up a little but, buying long is betting on an increase in stock price. To be "long" a stock is simply to buy it at one price, hoping to sell it for more in the future. To be "short" a stock, you borrow the stock from someone who already owns it, and sell it along to another buyer in the market. The "short seller" receives cash up front, pays a fee or interest to borrow the stock, and hopes to buy the stock back and return it to the original holder in the future. The short seller makes money if the stock price declines.
The "short interest" is a gross exposure. The total number of shares being held long, minus the number of shares held short will generally equal 100%. If the short interest in Gamestop (GME) was 140%, that means there were 240% of the number of shares in existence were being held long in peoples accounts.
Say that person A owns 100 shares of GME because they think it will go up. Person B thinks it will go down, so they borrow the shares from person A and sells those shares to person C. Now, person A and C both show that they have 100 shares, or 200 between them, but it is the same 100 shares! Person B has -100 shares, so the net number of shares is still 200 - 100 = 100 shares. To go further, person C could lend out their shares to person D, who believes the stock is going down and sells it to person E. Now there are 300 - 200 = 100 shares outstanding.