With many people still confined to their homes and less sport to bet on than usual, some stocks have become the target of those looking to speculate on something.
Over the last few weeks, GameStop, a little-known, loss-making electronics and computer games retailer became the target of this speculation. Driven by a relatively small group of retail traders, GameStop saw its stock price rocket throughout January before falling quickly back down to earth and stabilising as the table below shows.
Quite incredibly, over five trading days, GameStop’s share price increased by a total of 709% to a peak of $347.51 before declining just as dramatically and falling 73% in as many days.
The explanation behind GameStop’s rapid and meteoric rise is the result of simple supply-and- demand dynamics as well as the power of social media.
To begin with, several hedge funds had relatively large short positions on GameStop. This means that they borrow shares from someone, sell it to the market at the current price in the hope they can buy them back at a lower price sometime in the future. Their profit is the difference between what they sold the share for and how much they buy it back for (minus any interest or fees).
At the start of the year, GameStop had one of the highest short interest levels, meaning that a very high percentage of its shares were being borrowed to place short trades.
A smart and brave group of people on Reddit, an internet forum site, noticed these large short positions and decided to try and go after the hedge funds. By driving up the price of GameStop shares, they hoped to make these hedge funds suffer heavy losses (as the share price goes up rapidly, the short trades lose money: this is known as a “short squeeze”)
By promoting this trade to other retail traders, many more began to buy the shares using free trading platforms such as RobinHood. This created significantly more demand for GameStop shares than available supply. The price began to increase, drawing even more into buying up shares.
To add fuel to the fire, as hedge funds started to suffer losses on their short trades, they were forced to buy back shares to prevent further losses which pushed up the price even further.
At this point, so desperate was the mania to buy GameStop that many retail traders accidently purchased GME Resources, an Australian listed mining company with the same stock ticker as GameStop (GME), causing its price to rise by over 38% in a couple of hours.
In the end, due to the volatility in GameStop shares (including other technical reasons beyond this article), on 28th January RobinHood and some other trading platforms were forced to suspend dealing in GameStop shares.
Unsurprisingly, this created panic amongst retail traders, and many of those that were able to, began to sell, causing the price to fall by almost half on that day. Though GameStop briefly recovered the next day, since then it has been on a downwards spiral.
From the table above, the share price is now almost back to where it all started. As with any period of euphoria, though there were many winners, it is likely there were just as many losers who got in late and have been left holding the bag.
These periods of mania are not uncommon in financial markets and will always occur. However, what has increased is the speed at which information is spread and the availability for everyone to trade both cheaply and quickly. With this being the case, we might expect events like this to become more common in the future.
Written by Sam Chedzoy and Jonty Brooks.
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General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.
