By shorting a stock you can profit from a fall in its price. However, you also expose yourself to the risk of a sharply rising price, as in the GameStop short squeeze. TIP: Watch the movie Dumb Money to see a really scary example where ‘smart’ hedge funds lost billions in a short squeeze.  

GameStop and AMC are once again surging due to orchestrated short squeezes

The original GameStop Phenomenon: A Dramatic Surge in Stock Price that crushed the (supposedly) ‘smart money’

In the famous ‘Dumb Money’ short squeeze, the stock of American video game retailer GameStop soared from $20 to $450 in just three weeks, making global headlines. This was one of the most dramatic rises in stock price ever recorded. How did this happen?

The surge occurred because the stock was shorted at an unprecedented rate of 140%, higher than any other stock on the American market.

The short sellers were hedge funds with significant capital. They were unprepared for millions of small investors to organize against them via the Reddit channel WallStreetBets and buy up all available shares.

This created a “short squeeze,” a pressure to repurchase the shorted shares, forcing the hedge funds that borrowed the shares to buy them back.

To understand this phenomenon, one must be familiar with the concept of short selling.

What is short selling?

Short selling occurs when shareholders lend their shares to someone else, who then sells the stock hoping the price will drop. They then buy back the stock at a lower price, pocket the difference, and return the stock to the original shareholder.

A short seller profits from the difference:

Current Sell Price – Loan Interest – Buyback Price

For example:

10 USD – 1 USD – 5 USD = 4 USD profit

One only shorts a stock when they are very confident that the stock price will decrease. In GameStop’s case, everyone believed the company was on the brink of bankruptcy.

The major risk with short selling is that the downside is nearly unlimited, while the upside is limited.

Short sellers can potentially lose much more money than they can earn. Here’s how it could look for the hedge funds that shorted:

$20 – $2 – $150 = –$132 per share!

In this theoretical example, the hedge fund has lost 6.6 times its original investment!

How Could GameStop’s Stock Rise So Much?

Because many people bought the stock simultaneously via Reddit, driving up the stock price. This, in turn, scared the hedge funds, which—intending to minimize their losses—bought back their GameStop shares at a higher price than they sold them for, allowing them to return the shares and exit their short positions. Here’s how it happened:

1. The large Reddit group buys all available GameStop shares, driving up the stock price.

2. Hedge funds fear losing large amounts of money.

3. Simultaneously, the loan interest on the shorted stock increases as the original shareholders perceive higher risk. This puts additional pressure on the hedge funds; if they want to wait out the Reddit group, they must pay higher borrowing costs.

4. If they choose to close their short position, they are forced to buy the stock to return it to the original owner.

5. This drives the stock price even higher!

6. Back to steps 2 and 3!

As you can see, this creates a chain reaction.

This is what is meant by a “short squeeze.”

This is why GameStop’s stock price rose so quickly.

And since short selling was so extensive (up to 140%, i.e., more shares shorted than the total number of shares in the company), a large number of shares were forced to be bought back by the hedge funds to close their positions.

How to Find the Next GameStop

– Check the number of days it takes to cover the short position (position/daily trading volume)

– Last but not least, it requires hype! There must be many others involved, like the WallStreetBets Reddit group example. You can’t break their position and create repurchase pressure alone.

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