*This is the first of two blog posts about the Gamestop ‘saga’
In January of 2021, a group of retail investors, armed with social media and trading apps, took on powerful hedgefunds, causing a surge in the stock price of GameStop. Today we will explore this topic, how it happened and the impact on institutional investors and the markets.
A little bit of background…
GameStop, a video game retailer, had been facing significant challenges due to the rise of digital game downloads and the impact of the COVID pandemic. Several hedgefunds identified its outdated business model and decided to take advantage. Institutional investors, including hedge fund Melvin Capital, bet against Gamestop’s share price. Betting against a company’s share price is also known as short selling.
What is short selling?
Short selling involves borrowing shares from someone else, typically this is an institutional investor such as a pension fund – this usually includes paying a small fee. The short seller then sells the borrowed shares at the current market price. If the stock price has dropped, the short seller profits from the difference between the higher selling price and the lower repurchase price. However, if the price has increased, they incur a loss.
The short squeeze: a Reddit masterpiece
Enter r/WallStreetBets, a subreddit where retail investors discuss stock trading strategies. The members of this subreddit noticed the heavy short interest in GameStop and saw an opportunity. They believed that if they could drive up the stock price, they could force the short sellers to buy back shares at higher prices to cover their positions, initiating a “short squeeze”.
And this is exactly what happened. Retail investors began to buy GameStop shares and options in large quantities, causing the share price to skyrocket from under $10 to a daily high of $86 – with an intraday high of over $350 on January 27, 2021. GameStop, a firm worth $250m at its lowest in 2020, now had a market capitalisation of more than $25bn.
Data: https://www.statista.com/statistics/1199882/gamestop-daily-stock-price/
The buying frenzy created a feedback loop. This meant that short sellers had to buy shares at the new high price to cover their positions. Since some hedge funds had borrowed and sold large amounts of GameStop’s shares, they faced massive losses, and had to buy back the shares to stop the losses from increasing further. This additional demand further drove up the stock price.
Impact on Hedge Funds
The consequences for short sellers were severe. Melvin capital, one of the prominent funds shorting GameStop, reportedly lost 50% of its assets in January 2021 alone, amounting to billions of dollars. These losses were so severe, some hedgefunds required emergency capital infusions to stabilise. Melvin Capital received a $2.75 bilion bailout from other hedge funds, including Citadel and Point72.
Conclusion
GameStop’s share price eventually declined but still remained higher than its presurge levels. The company captalised on its position, raising capital through stock offerings to improve its financial position.
This event highlighted the growing influence of retail investors, who, through social media platforms, can coordinate and significantly impact share prices. This incident also drew the attention of regulators, leading to discussions about market manipulation, short selling and the operations of trading platforms like Robinhood, which temporarily restricted trading in Gamestop and other volatile stocks during the buying frenzy.
Footnotes:
Néos Economist 
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