It’s More than a Game: Short-Sellers, Individual Investors, and GameStop

You may have seen the news the last couple of weeks featuring prominent mentions of GameStop, a video game retailer, and AMC, a cinema chain. Wall Street hedge funds and individual investors have been engaged in a contest of wills, of sorts, and the financial implications amount to considerably more than a player’s name in the high scorer’s list.

First, some background. GameStop and AMC are both publicly traded companies, and their stock has been the target of short-selling, mostly by hedge funds. Short selling occurs when someone sells stock they don’t own—essentially borrowing the shares—in hopes that the price of the shares will drop, allowing them to buy back the shares—“covering the short position”—with lower-priced shares. When short selling is successful, the short seller pockets the difference between the price at which the short sale was made and the lower price at which the short position was covered (less fees, commissions, and other costs). GameStop and AMC have both been struggling, which is the main reason they attracted short sellers’ attention in the first place.

Enter individual investors. A Reddit investing forum, r/WallStreetBets, began touting the stocks of the two companies, perhaps because many forum members were personal fans of GameStop and AMC. The forum has some three million members, and some of them began buying shares of the target companies, resulting in a rise in their share prices. Eventually, the increase in the stock price forced short sellers to begin buying the stock as their positions went beyond allowable margin limits. A “reverse cascade” effect ensued as more short contracts were affected (a “short squeeze”), pushing prices of GameStop stock up from $17 to $483, at one point. Elon Musk even got involved, tweeting about the situation.

Volatility in the stocks has been off the charts, forcing multiple halts in trading and causing several popular trading platforms for individual investors (Robinhood, TD Ameritrade, others) to begin restricting trades. Some investors have filed a class-action suit against Robinhood.

By Monday, January 25, short-sellers stood to lose some $3.3 billion (half of the losses came the previous Friday, when the stock price of GameStop jumped by 51%). GameStop closed on Thursday, January 28, at $193.60, down 44% in the day’s trading. The next day, GameStop ended the week at $325.

For those who mistrust hedge funds and their managers and those who like to root for the underdog, all this has been rather entertaining. It is unlikely that the feud involving these two stocks will affect many long-term investors; fewer than 400 mutual funds have positions in GameStop, compared with more than 5,000 holding Apple, for example. It seems possible that the speculative bubble around GameStop and AMC will eventually burst, as many other similar bubbles have, over the years. It also seems likely that the short sellers will lick their wounds and learn from the situation, revising their strategies for the future.

Of course, this type of highly speculative investing behavior—both of the short sellers and the individual investors bidding up stock prices—is not what we advise for our clients. Instead of focusing large percentages of assets in a single stock or strategy, we help our clients build broadly diversified portfolios that allow the markets to work for—not against—our clients’ long-term goals. If you would like to learn more about our individualized approach to investing, please contact us. And to learn more about coping with market volatility and its effects on your investments, click here to read our whitepaper, “The Informed Investor: Making Smart Investing Decisions in Today’s Volatile Market.”

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