There’s a lot going on in the stock market this week and both and Reddit in general are inundated with questions about it. This is an opportunity to ask for explanations for concepts related to the stock market. All other questions related to the stock market will be removed and users directed here.
How does buying and selling stocks work?
What is short selling?
What is a short squeeze?
What is stock manipulation?
[What is a hedge fund?](https://www.reddit.com/r/explainlikeimfive/comments/l6ptb7/eli5_what_is_a_hedgefund/)
What other questions about the stock market do you have?
In this thread, top-level comments (direct replies to this topic) are allowed to be questions related to these topics as well as explanations. Remember to follow all other rules, and discussions unrelated to these topics will be removed.
**Please refrain as much as possible from speculating on recent and current events.** By all means, talk about what has happened, but this is not the place to talk about what will happen next, speculate about whether stocks will rise or fall, whether someone broke any particular law, and what the legal ramifications will be. Explanations should be restricted to an objective look at the mechanics behind the stock market.
EDIT: It should go without saying (but we’ll say it anyway) that any trading you do in stocks is at your own risk. **is not the appropriate place to ask for or provide advice on stock buy, selling, or trading.**
In: Economics
Short selling involves borrowing a stock from someone who owns it with the promise to return it at a later date, and pay a small fee based on the value of the stock. You then sell the stock, wait for the price to drop and buy it back at a cheaper price. You then return the stock to the original owner and pocket the difference.
This allows people to make money off of a drop in the price of a stock. Unlike with regular stock trading, however, the potential losses of you are wrong are not limited. If you buy a $10 share in a company and the company goes bankrupt, you lose $10. If you short a company with a $10 share price, and that price jumps to $100 per share, you just lost $90.
Since the start of the pandemic, GameStop has clearly been struggling in a big way. Such a big way, that a lot of people, including major hedge funds, decided to short GameStop. A lot.
Let’s say I own a share of GameStop stock and you want to short it. I lend you my share, and you sell it. Now someone else wants to short the stock as well, so they borrow the share from the person you sold it to and then they sell it. And so on. If this happens enough times, you can have more people who owe back a share to the “original” owner than there are actual shares of the stock.
This happened to GameStop which had 140% of its share sold short. This presents a problem for short sellers if the price of the stock starts going up instead of down, because there aren’t enough shares to go around if they decide they all need to cut their losses and buy back the shares they owe at once.
Some smaller investors, including those at r/wallstreetbets, noticed this happening to GameStop’s stock and decided to take advantage. They bought up a bunch of shares themselves, driving the price up and further limiting the availability of shares. This caused some short sellers to pull out, which drove the price up further, which caused more short sellers to pull out, and so on.
Meanwhile, the attention brought to this story and the quickly rising share price caused more people to buy the stock in the hope of taking advantage of the meteoric rise in price to make money themselves.
Back in the summer, you could buy a share for $4 apiece. Yesterday, those same shares were $147 each. Today they’re $345. The big hedge funds that were selling the stock short are currently literally billions in the hole while the smaller investors are making money hand over fist.
That all said, GameStop is still a struggling company underneath it all. It is nowhere near as valuable as its current share price, which means that, eventually, the bubble is going to burst and the price is going to come crashing back down. Anyone who buys in at the top expecting it to keep shooting up is going to lose a ton of money. Anyone still shorting it at that time is going to make a ton of money, and anyone who bought it early and sells before it pops is going to make a ton of money.
It’s not entirely clear whether the hedge funds are going to wind up actually losing billions in the end or if they can recoup some of that when the bubble bursts (they may or may not come out ok), but there are definitely going to be a bunch of people currently riding the hype train who lose whatever they invest at this point.
Imagine you have a warehouse of bikes.
Now, I have a buyer that wants to buy a bike for $300, but I think that next week there will be a big discount and I can go buy a new bike for $100. I ask you if I can borrow a bike to sell to the buyer and you agree, so long as I can replace that bike in a week. I sell your bike and wait for the next week. Sure enough, the discount kicks in, I buy a new bike, and give it to you + a small fee for borrowing it. I make money and you have your bike plus the fee. That’s a short-sell.
But what if instead nobody is selling any bikes next week? The price goes WAY up because everybody who short sold NEEDS to buy. That’s a short squeeze.
Right, let’s see if I can explain this. Obligatory am not a stock broker, so please take what I say with a grain of salt, and I definitely welcome any corrections for things I get wrong.
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##Stocks and Shares
Let’s say you have a company called CORP, and that company has a board of directors. Now CORP wants to become publicly traded, so they announce that they will sell one seat on the board for $20. Alice hears of this and thinks that’s a pretty good deal, so pays them the money and now gets a small say in what the company does and in return CORP gets a little bit of extra money. This seat is a **share** in the company, which can be traded in something called the **stock market** (where people can buy and sell their stock in a company).
Now as the years go on, CORP becomes a global company and now everyone wants to be at the table. Suddenly Alice’s seat becomes really valuable. If Alice wants she can sell her seat for $100 now, or keep her seat and hope that CORP does better and sell it for more later on. Even though right now Alice doesn’t have any more money in her wallet than she did originally, she is still worth more money because the seat she owns is now worth more.
Importantly, when Alice does sell her seat, even if she sells it for $1000, CORP doesn’t actually get any of that money – they already sold the seat to Alice a long time ago for $20. However, later on CORP might apply for a loan, and the broker might look at the price of the seats at their table (their **share price**). If the price is really high, that must mean the company is doing well for themselves so the loan is more likely to be approved. Also, if anyone ever owns more than half of the seats at the table, then that person also effectively owns CORP. So CORP really wants the price of their seats to stay high.
##Short Selling
So what if CORP starts doing poorly? Well Bob ‘Shorty’ McScrooge might see this and see an opportunity to make money off of CORP’s losses. So what he does is he goes to Alice and asks her if he can borrow her seat. She reluctantly says yes, as long has he promises to give it back in a month. He takes this seat and sells it to Joe for $100. As the days pass, the price of a seat at CORP goes down. When the end of the month comes around, Shorty buys another seat back, but now that the price has gone down he only has to pay $20 (meaning he effectively made $80 since he originally sold the seat for $100).
Let’s say now that after Shorty borrowed Alice’s seat and sold it, CORP finds gold and now everyone wants to buy a seat again. Well now Shorty is in real trouble. At the end of the month, he still owes Alice her seat back, but now seats cost $1000 to buy. If Shorty can’t find a way to make the seats cheap again, then he might go bankrupt.
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## GameStop
This is pretty much what happened with GameStop (aka GME). They were doing really poorly and their share price was going down, so lots of billionaires borrowed stock (seats) and sold them, expecting the price to drop resulting in them making even more money at the cost of GME. Reddit realised this so bought all the stocks causing the price to soar, meaning the billionaires are going to have to spend lots of money to buy back their borrowed seats (costing them billions of dollars). Of course, losing billions of dollars is something billionaires would very much like to avoid.
## Robinhood App
Robinhood is an app used by a lot of everyday people to trade stocks, and was the tool used by a lot of redditors to make GME’s share price get so high. No matter what the billionaires did, more and more redditors started using Robinhood to buy more GME stock, causing the prices to get even higher (meaning the billionaires would have to pay *even more* to return their borrowed seats). So to try to drive the price down, Robinhood said it would no longer let people buy GME stock, and that they could only sell now (remember, the seats at the table are only worth something if people are able to buy them). This is illegal and has been widely criticised by US representatives from both parties as well as basically everyone who isn’t a billionaire.
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EDIT: Added Robinhood section
EDIT 2: Formatting and typos
All these specific eli5 questions and here I am just looking for the general “eli5 what the hell has happened?” lol
GME just went up 61% after hour tonight.
How come it is legal for brokerage firms to block customers from buying a certain stock but big investors like the said brokerage firms can buy in after hours after they manipulated the price by removing demands during the day?
As a retail customer, how can I trade after hour?
The only part I’m confused about is why hedge fund bros and actual Wall Street professionals think what WSB did was illegal or criminal? Why did Robinhood suspend all trading? Didn’t WSB play by the rules of the game, even if they screwed over some powerful people?
Edit: added last question
How do you know when stocks are being shorted?
Easy way to think about it…
You have 100 shares of company G stock that currently sells at $100. Your friend thinks the price will drop to $50 in one week, so he borrows your 100 shares with the contractual guarantee to return the shares back to you in a week.
He immediately sells those shares for $100. Now neither of you own those shares. But your friend still owes you the shares, so he’ll just buy it back from the market in a week when it drops to $50, return the shares to you and pocket a $5000 profit.
Only, the stock price doesn’t drop, it goes up. To $200. Your friend owes you 100 shares of stock, so he has to buy it from the market for $200. He return the stocks to you and has lost $10000.
Now bump the numbers up. Assume there are 1 million shares of the stock available, so he makes agreements to borrow all 1 million from the owners, yet somehow also manage to borrow about 500,000 shares that simply don’t exist. But since it’s a contract to borrow shares, it doesn’t matter…they’re just paper shares, and he’ll make a fortune when the stock drops. Except the share price doesn’t drop, and he owes people 1.5 million shares, but there are only 1 million shares on the entire market. So not only does he need to buy 1m shares at the new inflated price, he’s also got to somehow but 500,000 shares that are nonexistent. So in order to pay back those borrowed shares, he needs to buy them back from other owners, who are more than happy to sell them back to him at an even higher price than the day before. In short, the attempt to buy back all those shares that he owes but that don’t exist only pushes the price of the stock higher and higher and the losses just keep growing and growing.
If Melvin hadn’t gotten greedy and dumb and bought sell options that exceeded the number of shares in the market, they might have taken a big loss, but now they’re caught in a self-inflicted feedback loop where their losses only keep growing more and more as they try to fill their obligation to pay back all the shares that they owe.
This is why derivatives (assets “derived” from the value of actual assets) can be such dangerous bets…they basically were created to hedge risk, but Wall Street traders tend to just treat it like gambling. And…they not only gamble with the money, they borrow tons of it issuing the investment as collateral…and gamble with that. They think it’s an easy bet, so borrowing isn’t a big deal…unless they miscalculate the risk, which is how it can all blow up in their face. Which is exactly what happened in 2008. They had $100, decided to bet it all on black at roulette…but though the chance of red coming up was <1% so they borrowed another $9,900
to put on black. A dumb bet because they didn’t properly determine the risk of the bet.
This is about more than personal profit at this point. If you want to actually make a tangible difference in the system then buy and hold AMC, GME, or NOK. I won’t lie, you may lose your money but it’s about sending a message and making them hurt. If you have the money to spare and want to make a billionaire cry then buy.
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