(Disclosure: Some of the links below may be affiliate links)
Many of you have asked me to investigate what happened to GameStop stock. While it may be late, this will help you understand this strange event.
In 2021, the stock of GameStop, a company on the decline, increased more than tenfold, and many hedge funds lost a lot of money, driven by some individual investors.
It may have been the first time some well-organized retail investors have fought against big hedge funds and have caused big damage to them.
So, keep reading to find out what happened.
For context, we should talk a little about what GameStop is first.
GameStop is an American retail company that sells video games and gaming merchandise. They have thousands of shops in the entire world. They are the largest video game retailer. It is very famous in the United States, but it is not as well-known in Switzerland. But they have shops here as well.
They were a very profitable company for a long time. However, for almost a decade, they have been declining. Indeed, more and more people are buying their video games online. For instance, I have not bought a physical game in the last five years. But on the other hand, I have purchased many games online. And more and more gamers are doing the same.
As of 2021, GameStop is not making profits anymore, and its income is going down year after year. And they do not seem to have done much to adapt their business model to the new online gaming paradigm.
We can take a look at their stock until 2020 to see how was its performance before this event:
They had a nice performance from their launch in 2002 to the financial crisis of 2008-2009. After that, they recovered quickly but started declining in the mid-2010s once the shift to online game purchasing became apparent. After that, the stocks dropped to low prices, below 5 USD.
So, we can see that before 2021, GameStop stock was not a great investment, and the company is not in great financial shape. So, why did many people decide to invest heavily in this company?
I am sure that many of you never heard of wallstreetbets (WSB) before this GameStop saga. However, with this event, the wallstreetbets subreddit became quite famous. However, it was already active well before this event. But it has now become much more mainstream than before.
The WSB subreddit is a forum where stock market gamblers talk about their bets, often against the general sense of the market. What is interesting is that on this forum, people are not ashamed of posting their losses. There are many more failure stories than success stories on this forum. And some of them are posting massive losses and laughing about them. Of course, some of these investors are standard investors like you and me. But some have a lot of money and are willing to gamble.
It is fun to read some of the things on this forum. But you should not expect to find quality in most of the posts. It feels very childish.
Remember that just because some of these members made much money with GameStop does not mean you should follow everything you read on this subreddit. Also, keep in mind that these investors are taking on a lot of risks.
The GameStop plan
Some WSB investors studied the market and saw that several stocks were highly shorted by big hedge funds. This means that hedge funds were betting that these stocks would do poorly. For that, the hedge funds were selling shorts. They were not selling stocks they had, but stocks they borrowed at a higher price now, hoping to buy them back later at a lower price. This is a technique called short selling.
When you sell short, you will have to buy back the short later. In the meantime, you will pay interest on the loan. And if you become too leveraged, your broker could call your account, and then you would have to either put in more money or buy back the stocks directly. So, it is important to note that short sellers will have to buy back the stocks at some time or incur substantial losses. With short selling, you can potentially lose a lot of money than what you bet. The downside of short selling is unlimited.
The main heavily shorted stock was GameStop stock. Given the context I gave you on the company, it should not surprise that some people were betting on it getting lower. But other stocks such as AMC, Blackberry, and Nokia were included in the strategy but had less media coverage. Large hedge funds heavily shorted all these stocks. And all these are from companies that are not in great financial shape but were once great.
The plan started with the DeepFuckingValue user on the WSB forum. He held many shares and call options on this stock and regularly posted his updates on the forum. Initially, he lost money with these instruments but held on to them. And in the end, his portfolio was up more than 100 times. And he bought more and more as it went up. It is difficult to say if everything he posted is true, but he has been making a ton of money on this, several million dollars in profits.
So, these investors decided to try to do two things. First, they wanted the stock’s price to increase to make the hedge funds lose money. This was to be the revenge of the small investors against the big hedge funds. If many people are trying to buy some stocks and then holding onto them, this will increase the price of these stocks.
Second, they also wanted to create something called a short squeeze. This event happens when many short sellers have to buy stocks to cover their losses, and this causes prices to go up. With the growing prices (inflated by the WSB investors), more and more short sellers will move to cover their stocks, increasing the price further.
On top of that, if enough investors are not willing to sell, the price will increase faster. For this, the WSB investors would have to buy enough stocks (and hold on to them), so there would not be enough stocks for the hedge funds to buy back. So, they encouraged their members to hold on to their stocks and not directly realize their gains.
In the past, there have been several examples of large short squeezes. For instance, in 2008, Volkswagen shares went up by a factor of five in one day. But this short squeeze was orchestrated by large players, like hedge funds, unlike the GameStop event. For this reason, the GameStop short squeeze had much more mainstream media coverage.
The first phase
We can look at the stock once the WSB investors bought them heavily in late January 2021.
We can see that in a few days, the stock jumped from lows of below 20 USD to highs of more than 300 USD! The highest point during the day was even more than 400 USD. This is an impressive result.
As soon as the first surge in price appeared, many more investors joined the game to profit, pushing the price even higher. This was when the media coverage of the event started. And this media coverage caused even more investors to join. Many of these investors had nothing in common with WSB, and some were hedge funds trying to do some benefits by playing the up game this time. And many famous people, like Elon Musk, talked about this, increasing the hype even further.
However, it did not last long. Indeed, after a few days of euphoria, the price started to go down very quickly. The main reason was that several brokers halted the purchase of new shares. Indeed, on January 28, 2021, several brokers such as Robinhood, Webull, and eToro prevented people from buying new shares. Since people could only sell shares, some investors decided to cash in, and new investors could not join. This made the price go down very quickly.
Officially, these brokers claimed that they stopped allowing their users to buy these shares because of clearing houses raised the necessary collateral. Many people are citing conflicts of interest because these brokers derive a lot of their income from entities linked to hedge funds. There are still several investigations opened on this point. It will take a while until we know more about that. But this creates awful publicity for brokers that halted trading in these stocks.
We do not know how much hedge funds lost during the short squeeze. But we still have information that one hedge fund, Melvin Capital, lost 30% of its value compared to the beginning of the year. This is an impressive loss. And they had to be bailed out for 2.75 billion dollars by Citadel and Point72. I would not be surprised if other hedge funds lost a lot of money as well.
This is exactly what WSB investors were trying to achieve by showing that investors still had the power to make some large hedge funds lose money.
It is important to note that there are ongoing investigations regarding market manipulations during this event by the WSB investors. Therefore, we will still hear this story for a while.
The second wave
Interestingly, after 20 days, the stock started going back up. And since that point to the middle of June, the stock has been very volatile. It is currently much higher than it was before the first wave. But it has not been higher than during the first wave.
We do not know what is driving the second wave. But many investors on the wallstreetbets forum are still playing for the stock to go higher. So, w will have to wait and see how high it can go and who will win.
After finding out that some stocks were heavily shorted (betting against the stock) by hedge funds, some investors from the WSB subreddit decided to make the price surge to make these hedge funds lose money. In a few days, they managed to increase the price of GameStop stock (and other stocks) very quickly. As a result, several hedge funds lost a lot of money.
But after trading in these stocks was halted by many brokers, the price went back down very quickly. So many investors that entered the bet too late lost a lot of money. But many investors that started from the wallstreetbets forum made a lot of money by selling at the right moment or still holding shares.
The GameStop stock is currently very volatile, with huge daily price swings. And it remains much more expensive than it was before the short squeeze.
This is a very interesting story about the stock market and its volatility. Some very determined (and wealthy) investors can cause significant shifts in the market. And hedge funds that are supposed to know what they are doing can lose a lot of money very quickly.
This story shows perfectly the risks of the Fear Of Missing Out (FOMO). Many investors started buying GME at its peak, thinking that it would continue going up (like many people were saying). But they ended up selling at the bottom of the first phase because they feared the risks. So you should be careful about your emotions when investing. Emotions are not good investors!
For me, this shows the advantage of passive investing and investing in the long term. Keep it simple! Just because some people are making a lot of money does not mean they are doing something smart. They are most likely lucky and doing something incredibly risky. But many more people lost money in the operation.
I have not invested in GameStop directly, and I do not intend to invest in the future either.
I have tried to keep this short to know what is interesting and what was going on. But I did not cover all the details, because I think they are not interesting for most people. If you want more details, please let me know in the comments below. And if you want the long story, you can read RIP’s post about this saga.
What do you think about this saga? Did you invest in GameStop?
Download this e-book and optimize your finances and save money by using the best financial services available in Switzerland!Download The FREE e-book