Stock markets are completely rational and can be predicted using in-depth fundamentals and technical analysis. No matter how logical this statement may look, truth is that markets prove us wrong every now and then. A gut wrenching correction of over 15,000 points and fastest pull back rally ever to an all time high in a record time. Six of the debt mutual fund scheme wrapping up overnight to shining story of IPOs. Year 2020 has been a high voltage roller coaster ride for investors.

What is GameStop and What Happened?

But How?

For understanding the exact chronology, I’ll quickly brief on some unavoidable jargons as we go. I’ll keep it as simple as possible.

Short Selling

Short selling is a trade where you sell shares at a higher price and later purchase it when it’s cheaper. Say you are a trader and you are convinced that stock prices of a particular share are about to tank. So you sort of borrow some shares of that company at a higher price and sell them immediately. And later, you purchase those shares at a lower price from the market and return it to the lender.

Let’s try again with an example. You borrowed 10 shares of company ABC at Rs 10 apiece. Stock price of ABC falls to Rs. 3. So you purchase them and return it back to the lender. This is known as covering your position (also called square off). In this process you made a profit of Rs. 7 per share.

Moving on, what I just mentioned above is the happy path. What if the stock you bet short on starts moving up rather than going down? Well, you guessed it right. In that case you bear a loss of the difference amount. In theory, there’s no limit to the losses you can make.

Back to the story:

So there are mainly two villains in our story: these are giant hedge funds, Melvin Capital Management and Citron Research that were betting on downfall of GameStop and hoping to make millions out of it. Which is why they had shorted millions of dollars worth of stock.

Please note there’s nothing illegal in what they’ve done and this was a usual practice by these funds. In fact, with the might of their money and influence, these funds kind of increased their probability of success multifold. For example, in this case, they were found making YouTube videos on why they think GameStop would take a dip.

These redditors purchased every stock of GameStop available in the market. And as the price rose, they purchased even more.

And did I tell you that shorting is not that kind of borrowing where you can leave the country and get away with it. Sooner or later you have to square off your position OR in other words, return the shares you borrowed. Usually this would happen easily as there’ll be sellers willing to give away that share. But not this time. When Melvin Capital and Citron decided to bear a loss and cover their positions, there were no sellers. Redditors had held a big chunk of the stock and they had decided to do something called “short squeeze” to these hedge funds.

The emotional aspect

The entire fiasco is being viewed as a democratization of financial information. These fund houses make us believe that they are the only ones that can move the stock prices and economies and one should pay them to invest on their behalf. However, this event marked the end of this notion and shifts the power in the hands of retail investor.

It’s being considered as cool to hold the GameStop share no matter what and selling it is being considered as giving up and helping the cause of snooty fund houses.

Current Situation

As I am writing this article, Melvin Capital says that they have booked a loss and have covered there position. However, they had to take a funding of $2.75Bn in order to do so. An official statement is awaited from Citron.

Conclusion:

Please let me know if I have missed out on any aspect of the story in the comments section.

What do you think about this crazy episode?

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Until next time..