If you’ve been following recent activity on Wall Street in 2021, you may have heard the terms “short squeeze” and “short selling” come up. New York firms based on Wall Street that had been betting that the value of stocks in GameStop Corp, as well as Blackberry, Bed Bath & Beyond and AMC Entertainment, would plummet were shocked as trading volumes suddenly surged.
The surges originated from retail investors, with smaller scale trading accounts of between $500 and $2,500 joining forces in a financial contest against leading investment firms. Melvin Capital and Citron Research were among the large companies that had bet on GameStop shares dropping in value, in a practice that is known as short selling.
A definition of “short selling”
Short selling is the way investors are able to make money from stock that is falling. A short sale is when an investor borrows a share of GameStop before going on to sell it. Afterwards, if the stock price behaves as the investor expects, they can then purchase the stock at a much lower price, but keep any difference for themself. Out of all the stocks on Wall Street, GameStop is among the most heavily and commonly shorted.
However, during recent events, smaller US stock market investors stopped this process from happening. By banding together, they effectively helped raise the price of GameStop stock to unimaginable levels.
Online investor groups banding together
The small-time investors made use of online discussion boards and forums, including Reddit, to urge one another to purchase GameStop shares, resulting in a circumstance called a short squeeze.
In particular, a Reddit group entitled WallStreet Bets comprises discussions loaded with possible ideas for upcoming trades to take part in. Recent activity within the group saw members urging each other on to continue buying GameStop stock in order to push it even higher.
From its original position of sitting at about $18 for share, the GameStop stock rocketed in value, doubling within a four-day period. It didn’t stop there, however, but kept doubling and doubling before reaching $347.51. Eventually, it returned a portion of these gains and finished at end of day trading at $193.60. Although this meant that it was down by 44 percent, it was up for the first weeks of 2021 by an astonishing 928 percent.
What does the term “short squeeze” mean?
A short squeeze is what occurred recently with GameStop Corp’s stock. Stock that is heavily shorted and sees a rise in price can potentially force any short sellers to abandon bets. To do this, they must first purchase the stock, pushing the stock price even higher.
The pros and cons of short selling
There is no doubt that while short selling can be a profitable endeavour, the practice does come with associated risks. Although gains that can be made from short selling are capped, as stock can only reach zero are its lowest, losses are not, as there is no established ceiling for how high the price of stock can ascend to.