Chart of the week: Reddit Rebellion
GameStop (NYSE:GME) up more than 1600% month to date with most of the mania happening in the past week fueled by Redditors rebelling against Wall Street hedge fund managers shorting the stock causing a big short squeeze in the stock. Here’s what happened in plain English:
When Hedge fund short stocks, they are essentially borrowing and selling shares they don’t own, hoping for the price of the stock to go down so they could go back into the market and buy back those shares they have sold at a lower price and close their short position. However, the thing with short selling unlike buying regular stocks is that in theory, your losses are unlimited while your gains are only limited by your position size. Example: You buy (go long) a share of Apple for $130, your losses are limited to the $130 you invested while your gains are in theory unlimited (if you sell at $1,300 you make 1,000% return on your investment), however when you short one stock of Apple for $130 your maximum gains on the stock are $130 in the event Apple’s stock go to $0 and your loss potential is unlimited (if the stock goes up to $1,300 you lose 10 times the amount of your short position)
This huge move upwards in GameStop in the past couple of weeks have caused a lot of damage for short-sellers way beyond their original investments which has prompted a wave of short squeezes out of the stock, meaning that short-sellers were forced to buy back the stock quickly which ironically caused the stock to go even higher (i.e more demand).
Should you get in on the action?
The short answer is no. GameStop’s price action the past week was based on mass speculation rather than investment fundamentals, and whenever the public interest in the stock subside and the price revert back to the fundamentals, it’s the current shareholders (mostly retail investors) who are likely going to lose money.
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