Drama in the stock market: Gamestop stops the stocks

By Austin Boland-Ferguson

Over the past few weeks, a lot of attention was drawn to the stock market, but when looking at the market as a whole, it would not have seemed that way. Luckily, it was not hard to find which company’s stock was causing all of the fuss as of late: Gamestop.

Before diving deeper into the peculiarity of Gamestop’s volatile stocks, basic prospects of why common investors buy and sell stocks need to be understood. Normally, a certain company’s stock is appealing to an everyday investor when the company is a goliath in its field and has no signs of going out of business soon, such as Coca-Cola or Apple.

Stock could also be appealing if they belong to a company with long-term potential for growth, which explains the rising popularity in companies providing COVID-19 vaccines, such as Pfizer and Moderna, or the rise in stock prices for various cannabis companies as the marijuana legalization process across multiple states speeds up.

For separate reasons, each of these main motives to buy a stock indicate general trends of supply and demand of those stocks. It is popular to buy a stock like Coca-Cola because there is no indication that they will lose a lot of business anytime soon, which means people will not be likely to sell off a lot of Coca-Cola stock, keeping the supply and demand and the value of the stock rather stable.

For those “future growth” companies, people will quickly buy up stock at a low price, banking on the company’s projected future success to raise the value of the company. This steep decline in supply drives the price of stock up, which has been seen multiple times with electric car manufacturer Tesla.

In the case of Gamestop, supply was quickly going in the latter half of January, despite the video game retailer having no real prospects for future success. With an increased move toward a video game world without discs or cartridges, as seen with the release of all-digital versions of the newly-made Xbox Series S and Playstation 5 consoles, the middle man role that Gamestop played to distribute old and new video games has dwindled and may be non-existent by the end of this decade.

With a company as seemingly down in the dumps as Gamestop, how did they end up becoming the subject of one of the most meteoric rises the U.S. stock exchange has ever seen? The answer lies within hedge funds and a market tactic that is known as shorting.

A hedge fund, in oversimplified terms, is a collective of investment funds that pool assets together to be able to use well-studied, advanced methods of trading stocks to mitigate the risk of losing money and maximize efficiency in terms of using large amounts of money to make money. One of those methods is the shorting of stocks.

The process of shorting a stock is intricate but has the opportunity to make a lot of money when done correctly. Investors will borrow several shares from a stock of a certain company that is owned by someone else with an agreement to give that stock back after a certain amount of time, along with a commission fee for borrowing the stock.

For example, say an investor had a good hunch that Apple’s stock was going to be worth less in a month than it is now. The investor would go to borrow, for argument’s sake, 500 shares of Apple’s stock, with each share being worth $10, with a $100 commission fee once the stock is returned. The investor immediately sells those 500 shares, meaning they now have a hold of $5000. To the investor’s delight, a day before they are due to return those 500 shares to the original owner, each share of Apple is now only worth $5. The investor now only has to spend $2500 to get those 500 shares back, which when paying the $100 commission along with returning the shares, the investor has pocketed $2400 in the process.

Plenty of investors, namely within large hedge funds, were salivating over the seemingly guaranteed downfall in Gamestop stock. They were so certain of this drop that, according to Reuters, over 20 million shares of Gamestop were being shorted at one time or about $400 million worth of the stock around Christmas of 2020.

For the first few weeks, betting on the fall of Gamestop’s stock was seeming to be a worthy investment. Share prices of Gamestop fell to as little as $17.25 in the first half of January, which would have left those collective shorted shares with about $55 million in profit before fees. A large, easy payday was for those who bet against the game retailer — until the internet came into the picture.

Headed by the Reddit page “r/wallstreetbets,” an exponentially growing group of internet retail investors, many of which who take high-risk moves on the stock market with large amounts of money, started to point out an opportunity that could present two benefits to those on the forum: To try to bankrupt those who shorted Gamestop’s stock and make a lot of money in the process.

The process to accomplish those goals is extremely risky, yet quite straightforward: Buy large amounts of Gamestop stock using mobile investing apps such as Robinhood and hold onto them through thick and thin.

Through this, average consumers were able to ‘squeeze’ the supply of Gamestop’s stock, which with a sudden high demand for the stock, inflated the price of a share by large amounts, taking the $20 share up to as much as $483 in late January, which meant that those who shorted the stock would have to pay over $400 more per share when it came time to return the borrowed shares.

With some hedge funds losing billions of dollars and a large number of new, at-home investors making small fortunes of their own, creating a Robin Hood (pun intended) moment for the average investor.

Despite a large amount of loss from hedge funds during that time, many already have and will recuperate those losses from doubling down. Once they had returned stocks for a huge loss, many investors put into short the stock again, as many small-time investors were bound to sell the stock and cash in on the gains from Gamestop’s ballooning stock, eventually opening up the supply of stock again to bring the share price back down to Earth.

Though the stock is still above its pre-boom price, about $52 per share as of Feb. 15, the ‘big guys’ still won, with many smaller investors still feeling jaded over various trading services’ temporary stop on buying a certain stock, whether it was to protect new investors from buying into a company to lose a lot of money or larger investors, who could be a major client of the service, from losing any more money from the anomaly.

So what happens now? On the upside, there is now a large community of people, especially young people, who are learning the basics of investing, hopefully learning to make wise decisions that, with a bit of luck, will provide for them in the future.