Wait... WHAT'S Going On With the Stock Market?
Updated: Apr 7, 2021
Okay the minute this all blew up in everybody's face on all forms of the media I knew it was something I had to cover in the blog. The stock market is not something that is easy to understand, and I know a lot of people in my generation stay away from it because it seems so overwhelming. But I'm here to tell you that this is BIG and not something you want to keep your ears and eyes out of, entirely.
So, as you have probably seen the #tothemoon up and all over our screens, what does that mean? What are these hashtags representing? In a one sentence summary, a large group of Reddit users essentially beat Wall Street at their own game. But what is Reddit, what is Wall Street, and what is this "game" you're talking about, Grace?
To start, let's get some definitions out of the way. If you're REALLY in the dark, which no shame there, we'll start with the definition of a stock. "Stock of a corporation is all of the shares into which ownership of the corporation is divided. In American English, the shares are collectively known as "stock". A single share of the stock represents fractional ownership of the corporation in proportion to the total number of shares" (Wikipedia definition of 'stock'). The stock market is where investors can buy or sell said stocks. There are generally two types of investors, institutional investors, a company or organization that invests money on behalf of other (likely wealthy) people, and retail investors, everyday people like you and me. Now, what is Reddit? Reddit is a network of communities based on people's interests, and the community involved in this scenario is called "Wall Street Bets." What is Wall Street? Wall Street is a street located in the lower Manhattan section of New York City and is the home of the New York Stock Exchange or NYSE. Wall Street has also been the historic headquarters of some of the largest U.S. brokerages and investment banks. These banks tend to do a lot of investing via hedge fund. A hedge fund's purpose is to maximize investor returns and eliminate risk. If this structure and objectives sound a lot like those of mutual funds, they are, but that's where the similarities end. Hedge funds are generally considered to be more aggressive, risky, and exclusive than mutual funds. In a hedge fund, limited partners contribute funding for the assets while the general partner manages it according to its strategy.
If you get confused, feel free to refer back to these definitions while reading all of the tea that's going down in the stock market, currently.
Let's look at the market right now based off of when I am writing this, Jan 28th 2021 at 7:30pm. Take a look at basically any shorted stock it's pretty much up. The top 50 most shorted stocks in 2021 are up on average of 33%. If you look closely you'll find companies like GameStop and AMC up almost quadruple in the last few days, and even Blockbuster up a substantial amount of over 150% in a day. What do these companies all have in common? They are all companies that the market had basically decided were "dead" and institutional investors had shorted them into oblivion.
For those of you who don't know, shorting a stock is basically betting that it is going to fail. Short selling is very risky. "A long position has a maximum loss of 100% (if a stock goes to zero). However, a short position has potentially unlimited losses. This is because investors who short a company will have to replace the stock in the future at the market price. In theory, since stocks can increase to infinity, these losses are uncapped. There’s no telling how big of a loss a short-seller could take on a stock" (The Motley Fool).
Now back to the story. The popular Reddit page "WallStreetBets," a group of ordinary retail investors, predicted that these companies could be blown back to life with the support of their strong fundamentals. One user said "they made it through the pandemic so far, when things go back to normal they are going to flourish." Whether that was a lie to manipulate the market (which is illegal) or whether they genuinely believed this stock would go up is a mystery. But without proof of market manipulation, what they are doing is not technically illegal. Americans took this as a chance to turn the tables against corporate greed- specifically "hedge fund greed" - setting up the basis for potential short squeeze.
What is a short squeeze??? You have to be forced out of the stock you are holding. But why would anybody who is losing money on a stock not just hold on? Well, that's what this short squeeze is: In some cases, short-sellers can get squeezed out of a position and be forced to buy back shares at the market price. This typically happens if their losses exceed the minimum threshold a brokerage firm will allow. For example, consider a short-seller with assets of $100 million and an average margin requirement of 50%. If a short-seller loses more than $50 million on a short trade, a margin call can be undertaken by the brokerage firm holding this investor’s equities. This will force the short-seller to “cover” his position (buy back the borrowed stock he sold) and/or sell stocks to make up for the loss. Wall Street Bets took advantage of this opportunity for people who are mega holding short stocks to transfer wealth from the wealthy to average American.
In layman's terms, here is an example of both short selling and a short squeeze:
SHORT SELLING EX: You predict that Game-stop is going to go bankrupt. Currently, they are going for $20 a share. You borrow a share for $20, and sell it for $20, now do this 1,000 times. You now have $20,000 cash. But you also owe to the company 1,000 shares since you borrowed them. So you're even, right? How do you make money?
Let's imagine that this $20 share drops to $5 a share while in your possession. You can buy it at market value x1000, and you will have spent $5000. Then you give the company back 1,000 shares and, therefore, you profit $15,000.
The value of your debt ($20,000) goes down with the value of the stock. Since the stock price dropped, your debt dropped to $5,000. You can make that trade, and cash out $15,000.
This is an example of a short sale gone RIGHT. You made money, all is well. But what if it goes WRONG? And the stock goes UP while in their possession?
You do the same thing, you predict that Game-stop is going to go bankrupt. Currently, they are going for $20 a share. You borrow a share for $20, and sell it for $20, now do this 1,000 times. You now have $20,000 cash. But you also owe to the company 1,000 shares since you borrowed them. You're even.
But then, the shares go up to $100 a share. That x1000 is now $100,000. Since your debt moves with the value of the stock, your debt has suddenly increased from $20,000 to $100,000. Bu t you only have the $20,000 cash, meaning you owe an extra $80,000 that you do NOT have.
So why don't you just wait then? Everybody know that you shouldn't sell now because you'll be in debt by 80 grand. But, beacause the bank loaned you that $20,000, which means it is liable for this loss, the broker may call you. The bank then calls you in what is known as a "margin call" and says "pay us back right now." You will have to buy to cover, buy 20 shares at their market value of $100,000.
When you have such a bad balance, ($20k cash, $80k debt) the broker says "deposit money now or we will sell all of your other securities so that we don't lose any money." These hedge funds are FORCED to cover these short positions or else the bank will take their $20k along with any of their other assets. THIS IS A SHORT SQUEEZE. They buy these newly elevated shares at the elevated prices.
Now that we understand short selling and a short squeeze, what IS happening in today's market?
In today's current situation, Gamestop, a stock that was predicted to fail dramatically, went from as low as $3 to as high as $483 (as of Jan 27th). Given the situation explained, the short sellers' debt is going through the roof so bad that they are getting margined called so fast and needing a bailout. One example of this, Melvin Capital, a game stop short seller took a 2.75 BILLION dollar cash injection just to survive and have to give up future revenue to the company that came in to rescue them. Sitron has also had to get injections to stay afloat. These hedge funds have closed all of their GameStop positions. These were the people buying in mass quantities at 100-200 dollars a share. That money got transferred over to "average" investors who sold them at insane profits. This could be a ONCE IN A LIFETIME short squeeze, as Gamestop had an individual share potentially lent out for shorting multiple times making the company over 130% short at one point.
As if all of this wasn't crazy enough, it doesn't end there. This goes deeper than what we are seeing on a surface level. While this was going on, the NASDAQ (an American stock exchange) STOPPED ALLOWING TRADES. This meant platforms including Robinhood, TD Ameritrade, Charles Schwab etc. will NOT allow you to buy some of these top targeted stocks (including AMC and Gamestop). If you had bought the stock Thursday that is fine, you could still sell it, you just couldn't buy more which destroyed the momentum and reason of what people were trying to do in the first place- steal from the rich give to the poor. Which was a huge mistake on Robinhood because of the irony, could've been a great PR move! People have been blocked and censored (for "safety reasons" including that they don't want us to lose our money or that the technology couldn't handle the amount of traffic). The general public believe these to be excuses.
To play devil's advocate, anytime we interact with a stock, we just use Robinhood and the other platforms as an interface because they're nothing more than the middle man. Anytime we buy or short a stock, our orders get rerouted to the market makers which are the actual companies with the stocks that we wanna buy or short. This includes Citadel (one of the biggest short sellers of Gamestop stock) and so the theory is maybe its not the apps who banned us but it was the market makers? No matter who is to blame, they took away financial tools from us and only gave them to the wealthy, destroying the idea of a free market. to make it worse, Discord banned the Wall Street server. For doing the same thing that hedge funds have been doing FOREVER!
This was quite the crazy chain of events, but hopefully now you've got a bit of a better understanding! Let's use this information to stay in the loop on the stock market for now and forever, because it affects more than just the people involved.