Do you love memes? Do you love saying the word “stonks”? Are you on the internet in any capacity? If you answered yes to any of these questions, then by now you’ve likely caught wind of what is happening with GameStop stock. If not: Basically, the stock market is currently going buck wild, thanks to a group of rogue day traders who’ve been buying up GameStop stock and sending the price skyrocketing.
But... why? The answer involves a deep dive into bizarro Wall Street dynamics.
GameStop — yes, where you went to buy and trade video games in middle school — has been on a declining trend in the stock market for the past few years. Last spring, a few hedge funds decided to bet on the idea that GameStop stock would continue to tank. If it went out of business altogether, these hedge funders would make boatloads of money.
But people on Reddit started to take interest in the video game seller after alums from online pet food seller Chewy joined GameStop’s board last summer, stoking chatter of a potential turnaround. Redditors and their friends started buying shares in GameStop via apps like Robinhood, sending prices sky-high. This forced hedge funders to buy up even more shares to keep from losing money.
Now, the hedge fund Melvin Capital is facing staggering financial losses, Robinhood is letting its users sell but not buy stock, and retail investors — aka, regular people who buy and sell stocks — are heralding this as a major win for the 99%. Sort of.
First, A Quick Vocabulary Lesson
If your knowledge of the stock market ends with, “I contribute to a 401(k), I think?” then there are a few key terms to know to make sense of what’s going on with GameStop.
What the hedge funds originally did is called shorting a stock. It means they borrow shares in a stock that they don’t already own from another investor for a small fee and sell it. Ideally, later, they purchase it back at a lower price and return it to the original investor, keeping the change on the transaction. In other words, big-time investors can borrow against the idea of a company going bust, so they can make a bunch of money when that happens.
Here’s the catch: If a stock’s price actually goes up when you’re planning on shorting it, the investor will need to pay much more to purchase that stock back, says Anastassia Fedyk, Ph.D., an assistant professor of finance at the Haas School of Business at the University of California, Berkeley. This is where “short squeezing” comes in, says Fedyk. In order to not lose their investment, the original investors — the hedge fund guys — have to buy even more of that stock they had hoped was going to lose big.
“A short squeeze is … where the price of a stock goes up, but hedge funds are shorting the stock — so in order for them to not lose a whole bunch of money, the brokerage will buy back shares and they will also increase the price when buying them back,” explains Taylor Price, the founder of TAP Intuit and a Gen Z financial literacy TikToker. “Once they buy short positions back at market price, it has a snowball effect where the price continues to increase.” Which is exactly what’s happened over the course of the last few days.
Rocket Ship Emojis & Risk
All of this market drama is largely the result of a Reddit community known as WallStreetBets, which has over 2.5 million members who chat about stocks to buy and sell. While traditionally, retail investors — regular people who buy and sell stocks on their own, as opposed to a hedge fund run by professional analysts, portfolio managers, and traders — might ask their family and friends for advice on what to invest in, Price says that social media and Reddit communities have given these conversations a megaphone.
As Price explains, “When 2.5 million people get together to buy stocks, the prices go up.” Insert rocket ship emoji here.
“The initial buying pressure causing the initial losses was successful because it was a coordinated action, since a single individual cannot affect the market,” explains Michaela Pagel, Ph.D., the Roderick H. Cushman Associate Professor of Business at Columbia Business School. “Reddit was the platform facilitating the coordination.”
Reddit allowed individual investors to get a taste of the kind of market influence, and financial wins, usually reserved for the already very wealthy people who manage and invest with hedge funds. GameStop shares’ value has soared over 2,000% in the past month alone; at one point on Jan. 28, it was trading for nearly $500 a share. A similar situation is also currently playing out with AMC stock — yes, the movie theatre chain is now seeing its value rocket even though no one is going to movies in a pandemic. It closed at $19.90 a share on Jan. 27, and has gained in value by 839% this month. TL;DR: A lot of people just made a whole lot of money really quickly.
But Price says that while it’s true that a lot of people are making a lot of money right now, it’s also super risky. First, she says, many new investors don’t understand the implications of short-term capital gains taxes. “These people are winning on GameStop, but then they will spend this money and not put anything towards savings for taxes. Forty percent of their winnings are going to be taken away in taxes.” The other major risk, she says, is that a newbie investor may get so caught up in the immediate wins associated with GameStop that they fail to see the holistic risks associated with this kind of day trading, and invest too much in stocks. For people with student loan or credit card debt, investing in jumpy stocks like GameStop — rather than more conservative investments like mutual funds and index funds — can carry more risk since your success is tied to an individual company’s success, versus an average of a group of stock.
Changing The Playing Field & The Players
Despite these risks, one of the biggest takeaways of the Great GameStop Hustle of 2021 is that individual people — people who don’t already have a lot of money to invest — can influence the stock market and enjoy some of the winnings that Wall Street has traditionally claimed for itself. Says Price, “People are tired of hedge funds ruining the market, and are starting to show [them] who’s really boss.”
But as Pagel stresses, “The stock market is a zero-sum game, what one person wins the other loses.” And right now, Wall Street is losing. Robinhood is trying to stop the bleeding by freezing trading on GameStop stock to regulate the market, writing in a blog post that "We continuously monitor the markets and make changes where necessary." The move has come under fire from everyone from private investors to Rep. Alexandria Ocasio-Cortez and Sen. Ted Cruz. While Robinhood is marketed as a way to “democratize finance” by letting users buy and sell stocks without any commission fees, they’ve now been slapped with a class-action lawsuit for their newfangled GameStop restrictions, which users are calling less market stabilization to protect against “volatility” and more market manipulation.
Still, this frenzy has demonstrated that it is possible to democratize Wall Street. “We’re headed towards a social finance and social investing aspect — for life,” says Price, adding that Wall Street would be wise to start caring what people other than “traditional” investors think and want. As a content creator, Price hopes to make other people, especially younger women, more comfortable in sharing their own investment stories so that the idea of investors no longer looks like “an older, white male-dominated field.”
“The internet is opening the door for women in investment — and women actually perform better. Women tend to invest their portfolio at higher rates than males. We are getting into the markets. That’s not changing,” says Price.
She says she hopes that new investors whose interest in the market may be newly piqued because of what’s happening with GameStop “first off understand that investing is not guaranteed.” Price encourages anyone looking to get into investing to have an emergency fund in place to cover three to six months of their expenses and make sure their debt is all low APR, which keeps the additional fees associated with having debt lower. Then, she says, it’s best to start off conservatively, focusing on things like index funds and mutual funds. After gaining confidence with those kinds of investments, you can start to think about buying shares in individual companies. “Investing in individual companies like GameStop poses the highest risk,” Price says. “If you want to keep these winning for the long run and not just tomorrow, you have to think about how to best invest in yourself.”