GameStop is an American high street shop that sells games, consoles and other electronics; due in part to the pandemic and in no small part to the fact that game selling has moved online, it had not been doing very well and that was reflected in a pretty lacklustre share price – writes Christian Leeming.
In fact it was in such poor health that the buzzards had been circling overhead; in recent months, hedge funds had made big bets that shares in the loss-making company would fall (see ‘What is short selling? below).
It might have been just yet another example of hedgies getting richer as a result of the misery of others; however, this time the little guys got together and decided to give some of the ‘big swinging dicks’ on Wall Street a taste of their own medicine.
A veritable army of private investors, swapping tips on social media channels such as the ‘Wall Street Bets’ forum on Reddit, fuelled a buying frenzy which pushed up the price of GameStop stock and ‘squeezed’ the short sellers.
Valued at $4.01 per share six months ago, Gamestop stock entered the New Year priced at $17.25; on Thursday 28th January it briefly hit $469 before closing out the week at $325.
Profits and losses were made along the way, but the actions dealt a big financial blow to the hedge funds that had spent billions of dollars gambling that GameStop’s stock would tank.
The ripples are likely to spread far and wide as questions have been raised about trading apps such as Robinhood that ‘gamify’ trading, thereby potentially encouraging risky behaviour (Gamified investing apps could seriously damage millennials’ wealth) and also whether technology really does ‘democratise investing’ in the way it is claimed, after a number of brokers pulled the plug.
This classic David vs Goliath tussle has inevitably attracted the attention of Global financial watchdogs as such an affront strikes to the very heart of institutional and individual investment conventions; this is not just little and large, it is amateurs vs pros and the suits are not going to go without a scrap.
When several brokerages temporarily halted purchases of shares in GameStop on Thursday it caused outrage among the amateur investors, who accused the companies of working on behalf of the old-guard who were losing out to the army of newbies; some said they were preparing legal action, and anger even spread beyond the investment community, with rappers and US politicians joining the backlash against Wall Street.
In an extremely volatile market shares in GameStop soared by as much as 700% during the past week; AMC Entertainment and Blackberry, which have also seen huge trading activity, were among other companies also hit by the restrictions.
Regulators in the US and UK have fired warning shots over the frenzied share dealing saying they were monitoring activity for any potential lawbreaking, and warning traders that they risked huge losses.
In the US, the US Securities and Exchange Commission (SEC) warned against illegal ‘manipulative trading activity’, adding: ‘our core market infrastructure has proven resilient under the weight of this week’s extraordinary trading volumes.
‘Nevertheless, extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence.’ The SEC also said it would review actions that could ‘unduly inhibit’ and ‘disadvantage investors’, adding: ‘this is unacceptable’
The Financial Conduct Authority – the UK’s regulator said that traders should ensure they are familiar with all rules, ‘including market abuse’.
UK traders have also been sharing thoughts and tips on trading chat forums amid mounting concerns about misinformation and share ramping; London-listed companies such as publisher Pearson and Cineworld have also been the focus of social media attention, although with much less impact on their share price than GameStop.
In a statement on Friday, the UK regulator said: ‘The FCA is aware of the situation and continues to closely monitor trading in UK markets. UK investors should take care when trading shares in highly volatile market conditions that they fully understand the risks they are taking. This applies to UK investors trading both US and UK stocks.
‘Firms and individuals should also ensure they are familiar with, and abiding by, all regulations including the market abuse and short selling regimes in the jurisdiction they are trading in.’
Much anger has been directed at trading app Robinhood, which is one of a new breed of broker popular among a generation of younger, tech-savvy investors; as its name implies, the app seeks to give the little guy the opportunity to compete with the pros on a level playing field, but it caused outrage when it blocked individual investors from buying GameStop stock.
Democrat Representative Alexandria Ocasio-Cortez said: ‘This is unacceptable. We now need to know more about @RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit.’
Her tweet was shared by Republican Senator Ted Cruz who commented ‘fully agree.’ Tesla founder Elon Musk, whose shares have also been a favourite with retail investors, also commented, saying ‘absolutely’.
Under duress Robinhood said it would ease the restrictions late on Thursday; it also said it had raised more than $1bn from existing investors to bolster its finances amid questions about pressures caused by the buying frenzy.
Democrat Senator Elizabeth Warren, a supporter of tougher financial rules, said the chaos was another sign of ‘years of distortion in securities markets that have allowed the wealthy few to artificially inflate and deflate share prices and reap short-term profits while exacerbating wealth inequality’.
She said regulators must ensure that markets ‘reflect real value, rather than the highly leveraged bets of wealthy traders or those who seek to inflict financial damage on those traders’.
It seems that the fall-out from this episode will be felt far and wide, and with more and more people turning to DIY investing, the ramifications could be profound.
Regulators will no doubt continue to insist upon greater transparency and demonstrable ‘value’ for retail investors, but in this instance when the little guys stormed the citadel the drawbridge was abruptly closed in their face.
That appears likely to have considerable implications – unless someone manages to get some traction with an app that seeks to take from the rich and give to the richer.
What is short selling?
‘Short selling’ or ‘shorting’ is where an investment firm such as a hedge fund tries to make money by betting that a company’s share price will fall.
It pays a fee to existing investors to borrow shares in a company and sells them in the market; if for example, they are sold for £10 each, the seller waits until they fall to £5, and then buys them back. The borrowed shares are returned to the original owner, and the hedge fund takes the difference between the sale and purchase prices as its profit.
GameStop was targeted because it made heavy losses in 2020; roundly considered to be ‘failing’ it became the most shorted stock on Wall Street.
However, rather than see it ebb away, amateur investors poured money into buying the company’s stock and pushed up the price; in these circumstances short sellers face big losses as they need to buy back the shares they have borrowed quickly to prevent bigger losses – known as ‘covering’ – but this further adds to demand for the stock and pushes its price higher still.