The GameStop Lesson

Photo by Anna Nekrashevich on Pexels.com

The “Reddit GameStop Surge” in late January and early February has become a cultural phenomenon. And as the energy of these events defaults to the lowest common denominator sentiment, the spectacle is eclipsing the substance. Our understanding gets muddled, and the lessons are often distorted into less than helpful, or even harmful ones in the end.

So that we are all on the same page, whether you know nothing about the stock market or you know a great deal, here is an easy way to understand what happened.

It all happened around the “short sale” of stocks.

Most people get that we make money when we buy stocks at a low price, then sell them at a higher price. The higher the sale price, the higher your profit.

Significantly less people understand that you could “get” stocks at a high price and then sell them at a low price as an alternative way of making money. Because this seems counterintuitive, there is a great deal of confusion around this transaction and therefore what happed in the last week of January 2021, when the legend (and lesson) has it the little guys stuck it to the big professional investors. It was all made possible thanks to the organizing power of Reddit and the investment platform for small traders – Robinhood. We’ll dissect this lesson in a bit.

But first, how do you make money by betting a stock will go down? You should know that this is called “short selling” or a “short sale” and is a legal everyday method of trading stocks.

Let’s get the concept in an everyday example of life, outside the stock market. Say there is a hugely popular exercise bike, the Prowler. But you think that the craze is going to fizzle soon and the market value (what people are willing to pay) for the Prowler is going to go down. Right now, it’s selling for $1,000. You can make money by getting the bikes while they are high and returning them when they are low. And here is the key – you “borrow” the bikes from a dealer, and promise to get the dealer the bikes back at a certain time, regardless of their price.

As soon as you obtain the bikes through borrowing, you sell the bikes for $1,000 each, and get $10,000.

Now here is the funky part. You wait for the price to drop because of your “hunch” that the market price was going to drop substantially. You think the craze is going to die, that’s your only hope to make money now that you’ve sold them, because you still owe 10 bikes to the dealer. You hold onto the $10,000, and wait for the price of the bike to drop. It does. It goes down to $500 because nobody’s willing to pay $1,000 anymore, the craze is dying down.

Now that the Prowler bike can be bought for $500, you immediately buy 10 bikes @ $500 each for a total of $5,000. Now you have the (10) bikes you owe the dealer, AND $5,000 left over because when you sold them, they netted you $10,000. Not bad, right? Vastly oversimplified, but that’s the gist.

Now what would have happened if your hunch was wrong, and you borrowed the 10 bikes, sold them for $1,000 and then the public demand actually increased and the market price went to $1500? Well, you sold them for $10,000, but you owe the dealer 10 bikes that now can only be bought for $1500 each. So it will cost you $15,000 for (10) bikes you need to return the borrowed bikes. So you will lose $5,000 on the transaction.

Now simply insert the word “stock” for bike and “broker” for dealer and you have the stock market short sale basics.

So, as you can see these are small numbers. But institutional investors like hedge fund managers can be dealing with billions of dollars in stocks whether buying low, or selling short.

In the GameStop case, several big institutional investors (hedge funds) typically investing for wealthy investors and wealthy individuals themselves, made it know they were betting on GameStop, the video game retailer, on going down big. So they borrowed a huge number of shares of their stock (GME) to sell short. The Reddit group caught wind of it and decided to band together to do something to drive the price up, and cause the hedge funds to take huge losses. How did they do it? By harnessing the power of en masse, through the Reddit platform, where they communicated the plot. They started buying as a huge group with many, many small purchases but it was enough to drive the price of the stock WAY up. Like supply and demand when there is a lot of buying, the price goes up and when no one is buying the price lowers to attract buyers. But they had a plan to buy like crazy even with borrowed money which is VERY risky, because if you lose money you have to pay back your losses on your money plus the borrowed money.

In addition to social media platforms like Reditt, the second thing that is newly available to the retail investor is trading apps like Robinhood. These apps will allow for small purchases and minimal fees, lowering the barrier of entry into the market and opening it up to the masses. The combination of the communication possible on Reditt and the purchasing available on Robinhood were essential in creating the new phenomenon of amateur investor market manipulation.

The Reddit buyers succeeded in driving the price up to $350 from well below $50 in a matter of days … and they did demonstrate the power of social media, and uniting.

So for the first day, or week, it worked. And many believed that the little guy had stuck it to the big guys. And they did, for now. But many Reddit buyers had bought on margin (loan) meaning, they owed money back out of their profits so they NEEDED the stock to stay up. And the only way to do that was to keep buying more stock.

The day after the initial surge, Robinhood and similar platforms announced cessation of purchases of GameStop and a few other similar stocks that were in play. Many cried foul as if the big institutional investors and even politicians were “protecting their cronies” and squeezing out the little guy. But one more day revealed that the margin buying the Reddit buyers were doing required capital reserves which Robinhood depleted and needed to replenish. They did. In 24 hours trading was opened back up. As of the writing of this article GME is priced at $234, $116 down from the high of $350, but still 4 times what it was probably borrowed for by the short selling hedge funds.

So the cultural narrative is the Reddit guys are the poor masses, the “David,” and the hedge fund guys are the “Goliath.” We love a good underdog story, especially as America has become a nation of working poor in a small business and working class battering pandemic.

But if you are a Citizen Body reader, you’re not here for the easy, indulgent narrative, but the more nuanced truth.

In that truth, this is not over. The stock price is now a bubble. It’s been artificially inflated by a buying frenzy that has nothing to do with business fundamentals, or the real value of the business. As a matter of fact, it’s quite possible that the hedge fund short sellers were positioned to more accurately assess the likely worth of the business. Like any bubble, a burst is inevitable, and maybe some will sell high having bought for less than $234. Overvalued tech, overvalued .coms, overvalued real estate, all have shown us in the last two decades the perils of “irrational exuberance” as former Federal Reserve Chairman Alan Greenspan once put it.

In the less sensational truth, are the institutional investors that gained billions when the Reddit buyers drove the price to skyrocket. In hurting the few short selling billionaires, they helped other wealthy investors, perhaps unbeknownst to them. According to Bloomberg, Chewy Co-Founder Ryan Cohen added $1.8 Billion; Chinese billionaires Larry Chen and Wang Jianlin added $4.2 billion and $773 million, respectively; and Tootsie Roll CEO Ellen Gordon added $185 million.

So this particular tactic of sticking it to Goliath might just create as many billionaires as it destroys.

And lastly, but most importantly, in this truth is the moral motivation. The vengeance fueled motive to topple the haves … is this our best motivation, our most magnanimous selves? We’ve shown it to be sloppy and possibly helping a bad system as much as hurting it. Can we accomplish something better, more sustainable and higher road than a revenge “squeeze” on a few billionaires? Is the energy of vengeance as elevating as the organized energy of unity building a better system, a better vision together?

What if we used the social media power to harness the group of US toward using our power more positively and constructively? Our idea is to band together, not just on a stock, but in a lifestyle – to agree to Shop Small. Hundreds of millions of us swarming into the small businesses in our communities and online – directing our dollars not AGAINST the wealthy but FOR the middle, year round. The giant corporations will shrink to less monopolistic proportions; political influence they wield would shrink, and we’d be using the power of US, united, to create a million millionaires instead of a single trillionaire. And we’re only buying the things we already need anyway. And in this process, we meet more people, re-humanize and feel more connected and purposeful … less divided. The wealth will come, but the fundamental daily transactions should always be putting us in a position and process of strength in multiple arenas and as a design … not a momentary, and specious “gotcha” that serves egos more than mouths.

Published by John Katrina

TCB Member, Father, Co-Founder of The Citizen Body, technical philosopher, and artist.

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