There has been lots of discussion this week about “The Gamestop Short-Squeeze”. In past weeks it was all Crypto currencies with Bitcoin and Ether taking the headlines as the newest “easy money” in today’s investing world. So what is a “short squeeze”?
Well in simple terms, the average investor buys a share at a certain price and bets it will go up. This is called taking a “long position” in a stock, and if you are right, you make money on the difference between the lower price you purchased it at, and the higher price you sell it at.
The exact opposite of this scenario is called a “short position”. In this scenario, investors borrow shares at the current price from a brokerage (lender), and bet they will fall in price. If they are correct, they buy back the shares at the lower prices and return them to the lender, pocketing the price difference.
Back to the “short squeeze”. This week, retail investors launched a coordinated effort through reddit forums to teach hedge fund managers a lesson. Hedge funds typically take short positions, then through various devices, control the market narratives negativley to make sure these stocks are viewed as bad performers. With the negative news, the price tends to drop (those who hold shares sell into the negativity, and those who do buy back in do so at a lower price). Well, the reddit movement said nix to that, and fueled a coordinated buying frenzy from retail investors on the brokerage app Robinhood that sharply drove the Gamestop stock up. In this environment, investors who were playing the short game and saw the sharp rise, used a strategy where they bought more shares on the rising price to hedge against their losses. This action only drives the price higher. This is the phenomena known as the short squeeze. The rise in the share price squeezes the short positions out.
There were a couple other trading phenomenas that occured which helped accelerate the price rise, but the aforementioned are the basics of the “short squeeze”. In the end, should you invest? No!
Although the FOMO is real. There were winners and there were losers in this game, and the smoke hasn’t cleared from this one yet. Eventually, the fundamentals will take hold, and those who bought high and hang around long enough stand to lose it all.