For the past few weeks, the GameStop saga that shook up Wall Street has been at the center of discussion on the internet and stock market.  The GameStop share price rose from $17.25 on the first trading day of 2021 up to its climax at $483. This frenzy in the stock market caused staggering losses in some hedge funds and tremendous profits for investors. 

Let us take a brief look at the factors that led to this skyrocketing of GameStop’s share prices:

Hedge Funds and Short Selling

A hedge fund is an investment pool that utilizes risky methods, such as investing in their clients with borrowed money, in hopes of earning capital gains.

Hedge funds borrow a number of shares in a company they believe will tank. They then sell the shares in hopes of repurchasing the shares at a lower price as the company’s stocks decline. This process of trading stocks that the seller does not own is called short selling. Shorting a firm can be a risky strategy- if the stock price rises, one can lose fortunes.

GameStop has been declining as a business as high-speed internet replaces their video games and gaming consoles. The demise of GameStop made the company a target for short-sellers.  Hedge funds, including Melvin Capital Management and Citron Research, shorted GameStop and betted against the company’s success.

This shorting of GameStop triggered a response from Reddit on the internet.

Reddit and Short Squeeze

Reddit is a social platform that consists of a collection of forums in which users share news or opinions based on their interests. R/WallStreetBets is a subreddit forum in which members discuss stocks, as well as trading ideas and strategies.

When amateur R/WallStreetBets participants realized that hedge funds were shorting a large number of GameStop’s shares, they began to buy large portions of GameStop stock. This community with 8.7 million subscribers turned GameStop into a meme stock, a stock with just as much social and cultural interest as a financial interest. The Reddit community initially decided to buy shares for fun and “potential profit,” and GameStop’s stock became heavily influenced by people online.

Their actions increased the value of the company’s stock enough to start a short squeeze, a situation in which a stock jumps sharply higher, on January 28, 2021. The short squeeze forced hedge funds, who had bet that stock prices would fall, to buy shares and get out of their bets to avoid facing even higher losses. This ultimately shot up GameStop’s stock values as much as 928% during just the first few weeks of January 2021.