GameStop short squeeze

The GameStop short squeeze was a stockmarket event that took place mainly in early 2021, centering on the video game retailer GameStop. Professional market investors who expected GameStop stock to decrease in value attempted a moneymaking technique called short selling. However, their plans backfired when a large influx of amateur investors began buying into the stock, causing its value to rise sharply. A surge of panic buying, known as a short squeeze, caused the stock to exponentially increase in value in the early months of 2021. The event attracted widespread investor and media attention.

Background

The stock market allows individuals and groups to buy, sell, and trade shares of companies. A share in a company signifies a small amount of ownership in that company. A share of a successful company will yield profits, while a share of a struggling company may lead to loss. Stock markets have existed for hundreds of years. During that time, many stock traders have developed techniques meant to maximize profits and secure against losses. Some of these practices are complex, risky, or even illegal, but offer the tantalizing prospect of great financial gains.

One such technique is called short selling, or shorting. This technique may apply when an investor expects a particular stock from a struggling company to lose value in the near future. The investor looking to short sell will borrow shares of that stock from another investor, with the promise to return the same number of shares at or before a specified time. The short seller then sells the borrowed stock at its current valuation. If the short seller’s prediction is correct, the stock will lose value in the coming days or weeks. Once the stock has lost value, the short seller can repurchase the number of borrowed shares at a greatly reduced price. At that time, the short seller can return the borrowed shares to the original owner as promised, while keeping the profits made by their earlier sale.

Many investors have used short selling techniques to yield large profits. However, the tactic is extremely risky. If the borrowed and sold stock subsequently begins to gain value instead of lose value, short sellers may find themselves losing money instead of making it when they must repurchase the stock. An extreme example of a failure in short selling is known as a short squeeze. In 2021, a short squeeze on stock for the struggling gaming company GameStop caused mass confusion in sectors of the stock market and made international headlines.

Overview

GameStop is a retail chain offering video games and related computer entertainment products. The development of the GameStop company can be traced through numerous earlier companies, mergers, and buyouts dating back to 1983. In 1999, GameStop officially debuted as a franchise of strip-mall-based stores as well as an online site of the same name. The following year, further acquisitions added to the brand, which was incorporated in 2001.

GameStop became the largest video game retail company in the United States and offered a variety of related toys and other merchandise. The company prospered throughout the 2000s, though its success later waned due to rising competition in the market, largely from online commerce and streaming services. In 2020, the company’s in-person facilities suffered greatly due to the COVID-19 pandemic that caused nonessential businesses to lock down around the world.

GameStop was struggling in 2020, as reflected by its poor performance in the stock market. The stock price began to fluctuate that year, drawing increased attention from market speculators. Some investors felt that the stock would improve. These included Ryan Cohen, founder of the Chewy pet-supplies company and an investment firm operator, who bought heavily into the company and joined its board. However, many other investors believed that GameStop would continue its spiral into lower stock values.

At this time, several large hedge funds began using short selling techniques using GameStop stock. These partnerships, which use pooled funds to invest, borrowed existing stock with the promise to return it in the future, sold it, and waited to repurchase it at what they expected to be a greatly reduced price. However, the professional money managers did not foresee the events that soon transpired.

The fluctuations of the GameStop stock had attracted interest from amateur stock market followers. These included small brokers, online traders, and a variety of individuals who began to enthusiastically buy into the stock. Many of these traders were inspired by online Internet communities such as the Reddit group Wall Street Bets, a forum characterized by its darkly humorous and often profane commentaries on investing, which began focusing significant attention on GameStop.

By January 2021, this sudden surge of interest in GameStop continued to grow as it attracted more attention, intrigued more investors, and caused stock prices to rise sharply. This unexpected shift in fortunes led to the rare and often chaotic market phenomenon known as a short squeeze.

A short squeeze may occur following a period in which many investors participate in the short selling of a struggling stock. Whereas these investors are gambling on the stock falling, the stock actually increases in value. Short sellers see their plans backfiring and try to cut their losses. They rush to repurchase the stocks before the price becomes even higher, and they lose even more money. This form of panic buying only intensifies as the stock price rises at an otherwise inexplicably high rate.

In the GameStop short squeeze, the Reddit investors and others continued to buy into the stock, completely reversing the plans of the hedge funds and money managers that had been trying to short sell. The combined actions of the outside investors and the short sellers caused the value of the stock to skyrocket at a nearly unprecedented rate. Due to the artificial manipulations of the investors, the once-struggling stock rose more than 1,700 percent and briefly became the most actively traded stock on Wall Street.

The stock price peaked in January 2021 and made a partial return in March of that year but began a steady fall as interest waned and the panic and manipulations played out. Many investors made fortunes on the short squeeze, while many others lost enormous sums of money. Investing experts warn against participating in short selling and squeezing tactics because they can lead to financial ruin for individuals and companies, as well as degrade faith in the intended functions of the stock market.

The GameStop short squeeze revealed valuable lessons for the financial community, including investors. The event showed the power of social media and the Internet to influence financial markets. The short squeeze revealed public investors had the ability to obtain greater economic power than financial institutions. The short squeeze reaffirmed the market's volatility and caused an increased look into regulation. Finally, the GameStop event proved that financial markets are accessible to anyone interested, but financial education remains crucial in investing wisely. 

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