Everybody has heard of it. The great short squeeze of 2021. But what happened? How did so many everyday people make money (or lose it) in their face-off against Wall Street hedge funds?
r/wallstreetbets is a community on reddit that discusses speculative plays in the stock market. It is one of the main focuses of the GameStop (GME) short squeeze because a user in this forum is one of the first retail traders to recognize the problem with GameStop’s stock, it was over 100% shorted. What this means is that multiple hedge funds bet against the stock and were attempting to make the company go bankrupt. In order to accomplish this they borrowed shares of the company (stocks) and sold them way under market value in order to force the value of the company to sell at a lower price. This would normally be ok but the hedge funds messed up, they borrowed more than 100% of the available shares by borrowing some shares more than once. They did this over and over again until the price of GameStop stock was below $4.oo a share.
Now, all these stocks the hedge funds borrowed they have to eventually give back. If the stock went to $0 then they would be able to borrow over 100% of the available shares and give them back the lenders since the stocks would be worth nothing, however, someone noticed what was happening and started buying the available shares and not selling. The r/wallstreetbets community on reddit found out about what was happening and then thousands of users started to buy the stock too. This in turn started to raise the price of the stock $10, $20, $60 until the hedge funds started having to repay the lenders who let them borrow the stock in the first place. Instead of buying back the stocks they sold for pennies on the dollar, the hedge funds had to buy back at the increased prices dictated by retail traders which causes them to lose money.
Now, hedge funds don’t deal with hundreds of shares, nor thousands of shares. They deal with millions of shares of a company at a time. So when the hedge funds have to pay their debts the increased volume of buying back the shares causes the price of the stock to skyrocket, more people buy in which causes it to rise even more, and now the funds have to cover at an even higher price. This cycle goes on until the market breaks or the hedge funds go out of business.
Short selling at over 100% should be illegal or at least regulated in order to prevent situations like this from happening. However it is a refreshing turn of evens that large Wall street funds are nervous for once and are called out on market manipulation and their risky bets with peoples livelihoods.