(This article was written on the 31st January 2021, accurate at the time of writing)
Last week, we witnessed a historic moment. The infiltration of Wall Street. In very, very simple terms, we witnessed hedge funds lose over $19 billion and be brought to borderline bankruptcy, by a social media platform that is known for posting anime clips and creating memes. It was an incredible moment, but I figured it could do with being explained. So, I thought I would try and explain in simple terms, what happened, giving some key terms and a rough timeline of what happened. So, read on.
First off, here are some useful things to know, as these are the terms being thrown around at the moment, and they’re quite important:
Market manipulation is the act of manipulating the stock market in your favour, preventing heavy losses by artificially inflating a stock price. It is highly illegal, but has several grey areas. For example, if someone in the Financial Times recommends a stock to buy, they have to declare that they own that stock, as if you are encouraging someone to buy a stock you own, the share price will go up and you will profit. However, if you acknowledge you own that stock, it becomes financial advice, rather than market manipulation. The debate now: is Reddit guilty of market manipulation?
This is another vitally important concept in what is happening, but is quite complex. In simple terms, it is an investor profiting off of a company’s stock losing value. So, they invest in companies that are failing by borrowing their shares. For example, they borrow $50 in stock from GME. They then sell that stock for $50, and rely on it being sold back to them at a lower price before they have to give the stock back, so if that stock value goes down to $25, they only have to match the amount of stock borrowed when giving it back, meaning they pocket the $25 additional per stock. If the stock goes up to $75 dollars, they have to pay $25 dollars more than what they initially invested in. Therefore, these investors rely on the failure of a company, so companies like GameStop, which are likely destined to fail or de-value, are heavily shorted.
The more a stock is bought, the higher its value becomes. If large quantities of stock that is being shorted is bought by another party, then price is driven up and the people who were shorting the stock will have to pay back the additional costs. In this case, ‘shorting’ meant losses of billions of dollars to the ‘shorters’, large American hedge funds with the ‘squeezers’, the reddit traders, profiting.
A hedge fund is a combined investment fund, which brings a pool of money together and re- invests it, producing profits for their investors. The large amount of resentment against them comes primarily due to the insane levels of wealth Hedge Fund managers make, as well as how their career relies on the failure of small businesses, leaving ordinary people to suffer during incidents such as the 2008 financial crisis.
So, now onto what happened. Gamestop (GME), a company that resells video games (like the US version of Cex) has been failing, due to its popularity waning as a result of online shopping, as well as Covid closing retail stores. So, firms such as Melvin Capital (Hedge funds) relied on its likely failure, and ‘shorted’ its stock to turn large profits. These firms bought a lot of stock, due to it being a almost guaranteed source of profit. That is until WSB came along. No one knows how exactly it started, but a subreddit called r/wallstreetbets, originally a thread for amateur traders, caused a short squeeze (by encouraging members to rapidly buy GME stock) that drove the stock value from $20 (per share) to $469 last Thursday. What we have now witnessed, is mass investing from regular people, overthrowing the wall street ‘fat cats.’ However, this could end in two very different ways:
Profits. When the Redditors make large profits, they may get nervous and sell their stock, bringing the stock price back down. If that happens in masses, the hedge funds will be able to return the borrowed shares at a significantly lower price, without taking massive losses, and amateur traders who sell too late could lose their entire investment.
Holding the line. If the Redditors hold, when the hedge funds reach the deadline for returning their borrowed stocks, they will have to pay everything lost. We have already seen Melvin Capital reportedly lose 53% of their worth, so only one question remains: who falls next?
As I mentioned, no- one knows who started this proverbial snowball. What we do know, however, is this was a culmination of several groups of people. Bored 18 year olds, working with a population that was given a $1200 stimulus check to live off, with little to lose, joining together and collapsing hedge funds. This isn’t excluding those who lost everything in the 2008 housing crisis, and had Hedge Fund managers laugh and drink champagne on balconies, looking down at those who had lost everything with contempt. How the turntables. We’ve also seen a nice large input of money from gamblers, as due to all bets being cancelled due to Covid, what’s a better gamble than investing in a massive financial bubble, as who knows when it’ll burst? Oh, and Elon Musk, because why not.
I hope this helps, as a very brief overview of what happened. The day memes overtook the stock market. So, hopefully now you will be able to follow the events with a basic understanding of what is happening, and I’ve also added some links to build on what I’ve said in more detail.