What happened during the Game Stop stock craze in 2020?
In: Economics
Lots of things need to be discussed to give an elementary explanation. So when people trade stocks, the most common way people trade that more people are familiar with is the “long position.” This is when you buy a share of the company expecting the company to do well which could see future dividends and raise the price of that stock, which you can hold to collect your dividends or sell at a higher value. Another way people trade stocks is called the “short position” or just “shorting a stock.” Instead of buying a stock, you borrow the stock first, then you sell the shares you borrowed. This is fine as long as you give the same number of shares back when the terms of the loan expire. You then buy back the shares and return them to the owner. If you sold the stock at a higher price than you bought it back for, that’s profit. So people do this with stocks they expect to decrease in value. It’s a way to make money off of struggling corporations.
It’s technically possible for the same share of stock to be shorted more than once. If I loan you a stock, and you sell it, the buyer could then loan those shares to someone else who then sells them again. In this way, it’s possible for more shares to be shorted than shares of the company actually exist. This was happening to Gamestop’s stock, whose code on the market is GME. Many people expected GME to keep going down in value, so they shorted over 100% of their shares, which is generally seen as very risky for reasons that became clear in this incident.
The subreddit wallstreetbets is generally for retail stock traders to talk about stock trading. There were posts on there arguing that GME is actually a good stock to take the long position on because there are reasons to expect them to do well and that their stock price is undervalued, and because so many shares are being shorted, there are many people that will have to buy the stock at any price. And the more of them that are taking the long position, the more it’s going to go up. So many of these redditors started buying GME at once. The stock price exploded. Now many large stock traders had to buy these stocks at much higher prices than they were expecting. And when they bought the stock at a high price, that just drove up the price even more. Money managers were panicking. Some hedge funds went bankrupt. And some redditors were making millions.
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