On Thursday, January 2021, brokerages halted stock trades, which caused GameStop’s shareholdings, which had been at the epicenter of a trading frenzy spurred by a discussion board on Reddit, to plummet significantly. The price of a share of GameStop fell to 193.60 Australian dollars the same day, which was a decrease of 44.3 percent compared to the previous day’s closing price (Li & Pound, 2021). On January 28, 2021, Li and Pound (2021) accentuated that the stock had previously seen gains of over 25 percent and losses of more than 60 percent, and business was paused many times. Moreover, during the premarket trading session, at one point, shares were skyrocketing and momentarily topped 500 Australian dollars (Li & Pound, 2021). The news that Robinhood and Interactive Brokers were putting trading restrictions into effect circulated, which caused the stock to start falling. It remained negative for the whole trading session.
The stock prices stabilized and even increased briefly before taking a sharp turn for the worst later in the trading day. It was the first time that GameStop saw a fall to under 200 percent in six days. The erratic changes came after a rise that increased by more than 130 percent on Wednesday amid substantial turnover. Therefore, it can be deduced that investors buying stock should resort to buying long term stocks instead of short selling, which can affect the unpredicted nature of the market, leading to losses when not scrutinized.
A short sell is an instance where an investor engages in selling shares of stock that they have borrowed with the expectation of purchasing the shares back at a lower price later. It contrasts with the conventional method of investing, which aims to benefit from the increase in the value of a stock. According to Petras (2021), the context of short sell in GameStop entails the firm’s history begins with short sellers who lacked faith in the firm’s sustainability as the epidemic presented challenges to businesses that did not have a comprehensive digital strategy. Hence, investors who engage in short selling stand to profit from a decline in a company’s share price. If the price goes up, investors must cover their holdings by purchasing shares of the company at a new, higher price, which means the losses might be rather significant.
Currently, the GameStop’s shareholdings liquidity is at 56 million shares. Similarly, 36 percent of the total is held by the general public, 45 percent by organizations, and 19 percent by executives, including officials, directors, and others (Wieczner, 2021). Thus, the leading investors of the gaming retail include the likes of BlackRock Inc. and State Street Corp., the California Public Employees’ Retirement System, and the Kuwait Investment Authority performing such a vital role in short selling saga.
Reddit members on the WallStreetBets forum laid the groundwork for a short squeeze on GameStop in January 2021, which resulted in a significant increase in the price of the company’s shares. Market trends predicted that the price of the stock would decline. The stock price had grown by 1,500 percent by January 27 after two weeks, and due to its tremendous volatility, trading had to be paused many times during that period. Further, more than 175 million GameStop shares were exchanged on January 25, the second greatest amount in a given day. This figure is much higher than the company’s 30-day typical volume of 29.8 million shares. In this regard, short over float refers to the percentage of the float is the proportion of a corporation’s stock deflated by organizational brokers relative to the number of shares of a firm’s stock that are obtainable to the public.
In an email, Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, said that GameStop short-sellers suffered mark-to-market losses of about $383 million on Wednesday, bringing the total losses for the year 2021 to date to $6.7 billion (Malz, 2021). The day’s loss for AMC shorts was $291 million, suggesting that short-sellers have lost more than $1.3 billion this year (Malz, 2021). Based on statistics gathered by S3 Partners, about one-fifth of available GameStop and AMC shares are now being sold short.
The trending graph indicates that the median goal for GameStop Corp is 87.70, with high estimates of 90.00 and low estimates of 30.00. Further, the median estimate reflects a decline of -10.79 percent from the previous price of 98.31 (GameStop Corp, 2022). The present suggestion of two surveyed investment experts is to hold GameStop Corp. shares. Since April, this rating has been unchanged when it was raised from a sell rating to a hold rating.
Marking to market pertains to the regular settlement of profits and losses variation in the stock market value. If the stock cost rises on a trading day, the trader who purchased the security collects funding from the dealer who sold the stock, equivalent to the security’s new value. At the same time, if the security’s value decreases on a particular trading day, the dealer who sold the security receives payment from the trader who purchased the stake. Therefore, marking to market applies to short selling in that it provides investors with a clear insight into the right time to secure stock from a particular organization.
Investors borrow shares of a company to sell them at a given price, anticipating that the stock’s market value would be lower at repayment. Usually, when someone purchases a stock, they are placing a wager that the corporation’s share value will increase; thus, they stand to gain substantial gains if the stock falls. Unlike Retail Investing, which normally needs market participants to contribute lesser sums, Institutional Investing demands more significant investments. Due to their smaller transactions, individual investors may incur greater costs and commissions.
Increasing an investor’s access to the market may be accomplished via the employment of a trading method known as leverage, which enables the investor to pay less than the total amount of the investment. Therefore, leveraging is another form of short selling since it involves paying less money and expecting a high reward upon the stock market’s fall. In this way, short selling is a precarious investment since it is likewise a form of gambling which involves uncertainties that one can gain or lose.
Short selling contributes to market efficiency and stability; for example, short selling has a favorable effect on the general market quality by increasing its liquidity. It is advantageous, for instance, in bid-ask spreads and price repercussions. In this approach, short selling suggests that these liquidity indicators should improve. If a stock’s short sale were banned, knowledgeable short-sellers would be precluded from trading on unfavorable fundamental information. This would impair price efficiency, resulting in prices that are less representative of current knowledge and include more pricing mistakes at any one time. Therefore, liquidity providers in the stock must be paid for the increased pricing mistakes expressed by a wider bid-ask spread.
A short squeeze is an atypical circumstance that causes the values of a stock to rise rapidly. Further, for a short squeeze to emerge, an extraordinary number of short sellers are required to have stakes in the securities. The short squeeze happens when the price suddenly increases. When many short-sellers decide to quit their bets and reduce their losses, the circumstance occurs. Since short sellers leave their positions with purchase orders, the departure of these short sellers coincidentally drives up prices. The security’s sustained fast price appreciation also draws purchasers. The combination of fresh purchasers and worried short-sellers may produce a startling and unparalleled price increase.
It is improbable that retail investors only propelled the current market frenzy in companies such as GameStop. Some of the momenta were likely generated by the investment in call options. This is clear considering the magnitude of the daily trade volume. The company’s astounding gains, which have increased by more than 1,500 percent since the beginning of the year, have dominated the U.S. market. Traders on the opposite side of the gamble were compulsory to acquire additional stock to offset their losses due to investors rushing into companies with a significant percentage of their shares sold short; hence, this created short squeezes.
The gamma squeeze occurs when the underlying stock price starts to rise extremely fast within a short time. Thus, when investors put more money into call options, the market is forced to respond by increasing the amount of buying activity, which may result in increased stock values. Investors who bought call options and then sold their holdings when high stock prices may make a sizeable profit, but institutional investors forced to hedge short positions could suffer huge losses.
When one opens an order book and sees bids and requests orders sitting there, this is what the term market makers mean. In this sense, positive gamma is when market makers are long gamma and must trade against the price to stay hedged, resulting in a less pursuing and reduced squeeze. Nonetheless, negative gamma scenario, market makers are short gamma and must operate with the price to stay covered, which increases the possibility of squeezes in either direction. To hedge against a price increase, they will attempt to purchase long positions.
Therefore, market makers hold on to negative gamma, and this is because when the market’s gamma is negative, investors might expect higher returns than during periods when it is positive. When the market is in a negative gamma state, this indicates that there is, on average, a more considerable degree of volatility. It is vital to note that market makers trade with the direction of prices. Since market makers are probably pulling liquidity out of the market as a result of this, volatility may increase. Furthermore, when the market is at positive gamma, the market makers are investing in the opposite direction of price movement; thence, volatility in the market is reduced.
Using negative and positive gamma proxies encompass numerous liquidity characteristics. As a result, liquidity is essential in understanding the stock market’s long- and short-term movements. Long-term stock market fluctuations are favorably affected by trading activity and resilience, while spread or transaction fees and other trade expenses are negatively affected. The liquidity controls can have a short-term impact on the stock market. Therefore, turnover rate has a short-term negative influence on the stock market but a favorable long-term impact. Thus, it is essential for market players to consider anticipated changes in liquidity when developing and implementing stop-loss orders.
Mastering short selling requires straightforward entry tactics, impeccable timing, and defensive trade management. Therefore, some of these strategies work; however, sellers must implement regulations that improve these methods and reduce the chance of being trapped in a short squeeze.
Cap Short Selling: There should be limitations on the aggregate sum investors may short a company; this would avoid the significant losses incurred by Melvin Capital and other corporations.
Limit Margin Allocation Amounts: Retail brokerages such as Robinhood should impose stricter rules on margin accounts, where clients may utilize leverage to purchase shares.
Retail investors can beat institutional trader; for instance, the set of equities chosen by retail investors beat those of hedge funds and mutual funds throughout the rally, as retail investors’ stocks rose to more than 50%. In contrast, those hedge funds and mutual funds rose to a figure not exceeding fifty percent. Retail investors outperformed in part due to their swift acquisition of value equities as the surge gathered momentum. The rally has transitioned toward cyclical, small-caps, and economically attuned stocks, whereas high growth stocks surpassed during the down market and weeks of the upturn, to the advantage of institutional investors who switched to growth stocks during the drop.
Thence, it means that the notion can be supported by hotel and leisure business Penn National Gaming, one of the firm’s top retail investors, has soared to a staggering 184% since March 23. According to Praveen Paramasivam (2022), Royal Caribbean and Norwegian Cruise Line Holdings lead the list, rising 93% and 78% since late March. And, trading favorite Tesla was among the best performers, regaining 124% from March 23 (Praveen Paramasivam, 2022). Thus, setting a new all-time high as the market rallied and Chinese demand for electric cars rose.
In general, retail investors are thought to be uneducated noisy traders. However, new research indicates that retail investors acquire unique knowledge about smaller companies. Hence, they should not be referred to as noise traders again; it is wrong since the retail investors have managed to usurp renowned trading firms such as Tesla from the top stop.
Investing in the stock market is fraught with danger, particularly in the era of social media. Hence, it is vital to bring to valuable light facts that each investor should be informed of, such as the periodic volatility of the stock market and financial intricacies such as short selling.
The GME story taught an important lesson: the stock market may sometimes be manipulated. The “wallstreetbets” subreddit demonstrated how readily the market could be manipulated. Long-term investors are aware of the market’s volatility and invest with care to achieve evident long-term gain. Young and new investors have educated us on how to bet on the stock market.
Time and opportunity cost are vital components of any financial choices, particularly investments. The scenario at GameStop is not dissimilar. Even though the underlying economics did not adhere to conventional investing logic, market makers failed to account for the real worth of retail investors’ time during a pandemic. The economy benefits from speculation, but any high-risk venture requires balances.
GameStop Corp. (GME) Stock Price & News – Google Finance. (2022). Google.com; Google Finance.
Malz, A. M. (2021). The GameStopeEpisode: What happened and what does it mean? Journal of Applied Corporate Finance, 33(4), 87–97.
Li, Y., & Pound, J. (2021). GameStop’s stock closes down more than 40% after brokers place restrictions on trades. CNBC; CNBC.
Wieczner, J. (2021). Hedge funds and other short-sellers have lost an astounding amount betting against GameStop. Fortune; Fortune.
Petras, G. (2021). How r/WallStreetBets took down a hedge fund and rode GameStop stock to the moon. Usatoday.com; USA TODAY.
Praveen Paramasivam. (2022). Royal Caribbean, Norwegian Cruise cancel voyages amid Omicron scare. Reuters; Reuters.