Business Insane World

How hedge fund firms lost billions of dollars to a group of redditors

GameStop is a struggling American video game, consumer electronics, and gaming merchandise retailer, but if you go by the stock price it is more in demand than popular big techs like Facebook, Apple, Amazon, Netflix and Google group of stocks.

The shares of GameStop surged from $19 on December 31, 2020, to $197.84 on January 27, a whopping gain of nearly 1,900 percent.

It all started when well known hedge firms funds like Melvin Capital and Citron Research got interested in GameStock shares. These funds are known to target stocks that they feel are overvalued by going short on the shares.

Hedge fund is a type of alternative investment that seeks to generate high returns by investing in a pool of underlying securities. In other words, it’s a group of investors funds pooled together to purchase investments.

Short selling or short sellers are those who borrow shares and sell while hoping the price would fall further so they will be able to buy the shares at a lower price and return the shares to the lender.

Short selling is not illegal, it is widely accepted in most of the markets across geographies.

In the case of GameStop, the hedge funds had played their cards and were waiting for the shares to fall and make a killing. They had no idea that an online group on Reddit, where members exchange tips and stock ideas would put a spanner in their plan and the wound would be so deep that they would end up staring at bankruptcy.

The group members decided to use the most lethal weapon against short sellers called ‘short squeeze’.

Short squeeze is a term used by market participants to refer to a phenomenon where short sellers in a stock who have placed their bets on a stock’s fall, rush to hedge their positions or buy the stock in the event of an adverse price movement, in order to cover their losses. This leads to a sharp rise in demand for the share, and huge rally in share prices.

A series of users on the Reddit forum ‘Wallstreetbets’ noticed that GameStop was undervalued by the market and vulnerable to a short squeeze. GameStop’s low share price made it relatively easy for a large number of people to buy in with little money. As the share price rose and rose, more people bought in – both to trigger the short squeeze, and because the price itself was now a way to make money.

The short selling losses for hedge fund firms in Gamestop have surpassed an incredible $5 billion in 2021 as the company’s stock price continues to rise.