By Robert S. Bacarella | February 25, 2021
Recently, the sleepy videogame retailer GameStop went on the ride of its life. A band of Reddit users, led by Robinhood retail investors, started a buying panic as institutional investors were forced to buy back shares that they sold short, expecting the stock price to go down.
A “short position” is selling shares that you don’t own. The shares are borrowed from a brokerage firm with the objective of buying the shares back at a lower stock price. For instance, say you sold 100 shares of GME stock, which you borrowed, for $20 per share. Your proceeds from the sale will be $2,000. If the stock goes to $2 and you buy it back, to cover your borrowed position, you would realize an $1,800 profit. However, if the stock soars to $400 per share, you’ll have to spend $40,000 to buy the 100 borrowed shares back, resulting in a $38,000 lost!
GME was the second-most shorted company out of more than 6,000 companies listed on the stock exchanges. The company, with about 70 million shares outstanding, had a short position of approximately 100 million. Computerized algorithms picked up on this short position, along with declining trading volume, creating a perfect storm—or a “short squeeze” —propelling the stock from $18 to $483.
While this frenzy price movement might be an anomaly, it was eye-opening as to how amateur investors, empowered by a social media message board, could impact a stock price. However, all games eventually come to an end and it appears this one is about finished.
To put it simply, the easy money has been made. To invest in GME today is similar to the game of musical chairs. There are ten chairs left and 5 people left walking around them. When the music does stop, you will likely find a seat, as the interest in this game has been significantly reduced as many of the “shorts” have covered their short position and have moved on to a new opportunity. I believe you should do the same.