This leads to the second factor, which is mechanical. Image: Shutterstock How buying creates more buying Reddit users seized on the fact that hedge funds Melvin and Citron Capital had significant short positions in GameStop. With the price continually pushed up, Melvin was left with a stark choice: continue to go short, or realise its losses. Melvin may ultimately be right, and GameStop’s price will eventually fall, but retail investors who knew about Melvin’s bet forced it into an untenable position. This is a case of the well-known idea that “the market can remain irrational longer than you can remain solvent”. Melvin tried to sustain its short position because the hedge fund’s managers believe the stock is overvalued and has suffered massive losses as a result (last week, Melvin announced it was already down 30 per cent on the year). When a stock price surges, short-sellers must either put in more money to sustain their position or liquidate it. Investors seized on the fact that Melvin, and another fund called Citron Capital, had significant short positions in GameStop. How is it possible that small retail investors can drive the value of a company up like this? Two important factors have led to the situation. How long can Redditors remain irrational? The average volume typically traded for GameStop is roughly 10 million shares per day. GameStop surged in value by 92 per cent on 26 January (US time), leapt another 134 per cent on 27 January, and has traded more than 178 million shares. This increase has become a surge in recent days. In fact, the 50 most shorted companies on the Russell 3000 index have gone up 33 per cent this year. These individual investors started buying shares (and options to buy shares in the future) in GameStop, and other companies that had significant short positions. Now the little fish are eating the shark. Normally on the stock market, the shark swallows the little fish.
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Read more: Three useful things to know about fear economics (and how to contain it)Īs a result, the short-sellers have lost a lot of money and the retail investors (and anybody else with GameStop shares) have made huge profits.
Through platforms like Reddit (specifically the Wall Street Bets forum, which describes itself as “like 4Chan found a Bloomberg terminal”), these retail investors have worked together to drive prices so high that hedge funds have had to abandon their short positions. What made the past two weeks so unique was the heavy involvement of small individual investors in driving the action. A short position means Melvin was betting GameStop’s share price would fall (a reasonable bet, as the outlook for brick-and-mortar video game stores, is a bit like what happened to Blockbuster and other video rental outlets).
Melvin Capital is a hedge fund, worth US$12.5 billion (A$16.3 billion) until very recently, with a “short position” on GameStop. Image: Shutterstock Revenge of the little fish The New York Stock Exchange briefly halted trading while Robinhood and other brokers also restricted purchases of GameStop stock. How is this happening? The simple answer is it’s a power play, magnified by social media, between small retail investors who want some share prices to rise and larger hedge funds who have made big bets that those same prices will fall. The stunning price surge in GameStop shares, driven largely by hyped-up Reddit users with the aid of Elon Musk, has drawn the attention of the US government, led to calls for regulation from the head of the NASDAQ exchange, and even driven up the shares of an Australian mining company with a coincidentally similar sharemarket code. How does a small retail company that sells video games, worth less than US$400 million (A$524 million) in the middle of 2020, become a US$10 billion (A$13 billion) company in less than six months? How does its share price climb from about US$20 (A$26) on 12 January 2021, to US$347 (A$454) on 27 January – then fall back to US$193 (A$252) the very next day?
The GameStop drama of the past two weeks has sent waves through financial markets, and UNSW Business School's James Doran says the ease with which these stocks are being manipulated is cause for concern
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