The stock prices of several ailing companies have exploded in recent days due to Reddit users who saw a gap in the market. Amid the financial chaos, the value of cryptocurrencies like Dogecoin also saw a huge surge.
After users of Reddit page r/wallstreetbets realised that more than 100 percent of GameStop shares had been shorted, thousands of people decided to buy shares in the company. As a result, the value of GameStop shares quickly rose from just under 20 dollars at the beginning of the month to more than ten times that amount.
Failed attempt at shortselling
Hedge funds have anticipated GameStop’s downfall coming for some time. The company sold video games in brick-and-mortar shops, where the trend is currently heading towards digital downloads. Combined with the corona pandemic, which reduced the popularity of phyisical shops even further, bankruptcy seemed to be just a matter of time.
To take advantage of the declining value of GameStop shares, hedge funds decided to short the company’s stocks. In exchange for an interest rate, the funds, mainly Melvin Capital, borrowed shares from other parties and sold them on. As soon as the value of the shares had dropped a bit, they bought them back for a lower amount. The difference was profit for Melvin Capital.
In the case of GameStop, this went on to an enormous extent. Some shares had even been shorted multiple times over, so that in total some 140 per cent of the shares had been shorted.
These borrowed shares must eventually be returned, even if the stock rises. The more the value of a share rises, the more interest the shortseller has to pay and the more losses it will suffer when he sells the shares back. Unlike losing an investment when the stock falls, the shortseller can lose more than the initial investment. There is no theoretical limit to how much this loss can be.
This skewed situation was noticed by Reddit users, who decided en masse to buy GameStop’s shares. Partly they saw an opportunity to make a lot of money because the hedge funds would eventually have to pay, and partly out of frustration with big companies that make loads of money by shifting money back and forth.
Other stocks popular as well
Because of the fuss, other ailing companies also saw their shares rise sharply. AMC Theatres, an American cinema chain, was also the target of the buying frenzy and rose by more than 400 percent. Electronics companies Nokia and BlackBerry also saw a sharp rise. This is because these shares, too, saw a large number of shorts, albeit to a less extreme extent than GameStop.
Robinhood halts trading
The chaos was briefly halted when Robinhood, a popular app with traders on Reddit, halted trading in the affected shares. Other apps soon followed suit. This led to anger from all sides of the spectrum, including Ted Cruz, Alexandria Ocasio-Cortez, Donald Trump Jr and even Tesla-CEO Elon Musk.
Dogecoin and bitcoin caught in the chaos
Musk, in particular, has had a big part in the uproar. With one tweet, containing only the text “Gamestonk!!!”, he further inflated GameStop stocks. Later, he also tweeted a joke about the cryptocurrency Dogecoin and put “#bitcoin” in his Twitter profile. As a result, the values of these coins also skyrocketed.
Outcome not yet certain
Where and when this chaos will eventually end is not certain. The hedge funds still have to sell back a lot of their shorted shares and in the meantime are paying through the nose for interest. It will probably be a fight over who can hold out the longest: the small buyers for whom it is tempting to sell their shares to make a profit, or the hedge funds that want to limit their losses as much as possible.