Inside GameStop's Short Squeeze And An Influential Play By Retail Traders

  • Stock Market Analysis

The words GameStop (NYSE: GME ), Robinhood, Hedge Funds, even companies like Nokia (HE: NOKIA ) and Blackberry (TSX: BB ) has been in the news these last couple of days. What is shaking up Wall Street and why are retail investors going gaga over shares of the American video game company, GameStop?

It all started with a Reddit thread also known as a subreddit named ‘WallStreetBets’ where investors discuss various stocks and options’ trading. The video retailer GameStop was valued at $2 billion in December 2020 and now, is worth roughly around $20 billion.
GameStop's Share Price
Source: Google (NASDAQ: GOOGL ) Finance, Tavaga Research (as of 28th January 2021)

What really happened and how are hedge funds involved?

Hedge funds are investment pools that work to maximize returns with minimum risk. Hedging essentially means taking investment positions with associated opposite positions, in order to reduce the risk attached to fund exposures. A simple example would be hedging the market risk involved in stock market investments by including gold in one’s investment portfolio, which helps deal with market fluctuations. Similarly, hedge funds take long or short positions for their day to day trading activities.

Taking a long position would simply translate into holding onto the stocks of a company, with the prediction that their price will only go upwards. Likewise, shorting shares or taking a short position is selling the shares of the company whose price is expected to go down.

Further, a shorting or a short sale means investors borrow the stocks of a particular company and sell them in the market, expecting their price to fall. Then if and when the price of the stocks fall as they wanted it to, they buy it at a lower price, thereby making a profit from the difference in prices.

Similar was the situation in the case of companies like GameStock, Nokia, Blackberry, AMC entertainment, etc. At least two big hedge funds and other professional investors had shorted the stocks of the above-mentioned companies, thus hoping to make a profit from the predicted fall in their prices.

Now comes into the picture the Reddit group ‘WallStreetBets’. The subreddit group has more than 3 million members and this is where the idea of buying/ holding onto GameStop stocks went viral. GameStop as a business has more than 5000 retail stores, which are not doing well. About a month ago when their stock price stood at around $15 USD, hedge funds including Melvin Capital, Citadel, and Point72 started shorting their shares.

A group of anonymous investors from the Reddit group chat, however, decided to go against the short bets of the hedge funds and started buying the GameStop stocks through free-trading applications like Robinhood and E-trade. This drove the price of the stock high instead of the predicted fall by these hedge funds. The stock price almost reached $500 USD at one point. This put hedge funds in a squeeze, as they had to close their positions, and the frenzy of covering their positions led to a further sharp rise in the stocks of GameStop.

A similar purchase in struggling stocks of companies like Nokia, AMC entertainment, and Blackberry was also seen from this community of members of the WallStreetBets Reddit group, leading to a similar increase in their stock prices. So far, hedge funds have already lost more than $5 billion this month.

Robinhood, Interactive, and many other brokerage houses issued curbs on buying stocks of GameStop and other companies. GameStop's stock price now stands at $193.60 as of 28th January 2021, falling 44.3% vs the closing price on the previous day. Furthermore, the stock prices of AMC Entertainment fell by 57%, Blackberry by 42%, and Bed Bath and Beyond by 36% as of 28th January 2021.

What does this mean for retail investors?

India’s retail investors who deal in foreign securities directly through various foreign broker partners should be cautious in these kinds of scenarios. The stock prices of the above-mentioned companies were driven upwards by retail investors, yes. However, this rise was followed by a fall in their stock prices as well. The excitement and talk around this rally in prices, come with big risks and could die down soon.

Diversification is important but not at the cost of high-risk. Therefore, retail investors should prefer investment funds such as ETFs or Index funds to take global equity exposure.

Currently, in India, there are 3 passive funds (and many soon to be launched) that facilitate global diversification, namely – the Nasdaq 100 ETF and the S&P 500 Index fund of Motilal Oswal (NS: MOFS ) AMC, and the Hang Seng ETF of Nippon India. SEBI Registered Investment Adviser like Tavaga can help investors in choosing the right ETFs out of the big bouquet of passive funds available out there.

Can Indian investors expect anything like this on NSE/BSE?

Short selling in India for shares is permitted, however, investors have to settle their positions by the end of the trading day. Therefore, the question of building short positions for a period or more than one day is impossible in the Indian context.

Neither the hedge funds nor the institutional investors can take a short position in the cash market and carry it forward to the next day. Therefore, it is highly unlikely that such a situation could play out in India.

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  • Narpat Panwar @Narpat Panwar
    continue down fall
    Like 0
  • Hemant Khandelwal @Hemant Khandelwal
    Waiting for a movie on the subject...
    Like 0
  • Abhishek Bal @Abhishek Bal
    I am happy. For once the retailers rode over the hedge funds. Phenomenal.
    Like 5
    • Nitin Mathur @Nitin Mathur
      @Abhishek Bal Yes, this was kind of surprising. Institutional investors and hedge funds, henceforth, will stay cautious from doing anything like this. Not only the young retail investors benefitted, but also the retirement funds which invest into various index funds.
      Like 0
    • Nitin Mathur @Nitin Mathur
      @Nitin Mathur Various index funds had also invested in GameStop and others as the latter is a part of Small-Cap indexes. Thus benefitting index investors as well.
      Like 0
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  • Gunda Karthik @Gunda Karthik
    it's a game play of retailers vs the hedge funds companies and the retailer grab over the bigges but in end all resulted with huge loss to the market
    Like 3
    • Nitin Mathur @Nitin Mathur
      @Gunda Karthik Partially agree. If a retail investor failed to book profits on time, he/she ended up trimming profits/making losses.
      Like 0
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  • Gunda Karthik @Gunda Karthik
    it's a game play of retailers vs the hedge funds companies and the retailer grab over the bigges but in end all resulted with huge loss to the market
    Like 1
    • Gokul Ch @Gokul Ch
      Gunda, how did the market loose? Its zero sum game, isn't it?
      Like 0
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