I am sure that by now you have all heard about the stock market’s most recent controversy: a drama that has left amateur investors millionaires and the powerful figures of Wall Street pulling out their hair. And yes, I am talking about the current GameStop Market Situation. In order to understand how a group of investors who collaborated on Reddit outsmarted Wall Street, we need to first break down how the stock market works and why the GameStop stock was used.
Think of the stock market as a shop that sells apples. Each apple costs the same amount of money. However, this set price can fluctuate based on supply and demand. If the supply of apples is low but there is high demand, then prices surge. If the supply of apples is high, but there is low demand, then prices drop. In this metaphorical world, each GameStop stock is comparable to an apple. The apple store is located on Wall Street. Let’s say that Tim, an investor, has many apples which he bought from the apple store. As supply and demand has fluctuated, so has the value of Tim’s apples. If Tim bought his apples in 2008, during the recession, the value of those apples would have been very low. However, since Tim held on to his apples, their value has increased dramatically as the economy bounced back.
Due to this increase in demand for apples, Tim is now much wealthier. Large companies, created by the joint effort of multiple investors like Tim, have the ability to predict whether an apple’s value will go up and down. These large companies sensed that the apple’s price would decrease significantly in 2021. These large companies, who have a buffer for profit and can afford to take risks, began borrowing all the apples that were available, both from the apple store and from individual investors. These large companies then decided to sell all of these borrowed apples for their current rates. Then, after the price of apples had declined drastically (as they had predicted), companies bought apples at this cheaper price and gave them back to the apple store and the individual investors they had originally borrowed from. Since the value of the apple had decreased, the people who lent their stocks lost money while the large companies made a profit.
The analogy above explains a process called shorting on a stock. When hedge funds “bet on a declining stock”, it means that they predict a decrease in its value. These hedge funds then short the stock, which means that they borrow the stock while it still has a high value. Then, these hedge funds sell the stock immediately, before the value of the stock decreases. Once the stock has sufficiently lowered in cost, hedge funds buy apples to pay back the people they borrowed from. Therefore, since the price of the apple is very low when they have to buy it back, these hedge funds have made millions in profits. Now, where does Reddit fit into all of this? Back to the analogy …
A group of amateur investors on Reddit began to notice that large companies were shorting all the apples in order to make a profit. In retaliation, individual investors banded together and through social networking (via Reddit) began buying the remaining apples instead of borrowing them like the companies were doing. This sudden increase in demand made the value of the stock swell and individual investors were suddenly finding thousands of dollars in their accounts. However, large companies were in a severe crisis. They had just borrowed so many apples and sold them at a moderate price. Now that the price of apples was exponentially high, these large companies had to pay immense sums of money in order to buy back the apples and repay the people they had borrowed from. The influence of these “Reddit Investors” had changed the prediction large companies had made about the declining price of the apple. By inflating its costs, Reddit Investors were the individuals making a profit while leaving large companies in turmoil.
In the real world, instead of apples, hedge funds had bet against the stock of GameStop. They believed that this declining stock had no chance of recovery and therefore began shorting the stock (borrowing and selling it at a high price only to repay at a lower price). However, investors who joined forces through Reddit drove the price of GameStop stock up by increasing demand after hedge funds and borrowed and sold the stock. As a result, individual hedge funds were forced to pay billions of dollars each in order to re-buy all of the stock and repay it.
So where does this leave us? Well, for those who have invested in GameStop’s stock as individuals … the future does not seem so bright. At its all time high during this rapid increase in value, the GameStop stock reached $347.51 per stock, from its original $9.77 per stock in October of 2020. Currently, GameStop is valued at $51.20 per stock. However, many of those who invested against the interests of hedge funds find themselves unable to actually receive the money they should have gotten. This is because many of these amateur investors traded stocks through an investing app called Robinhood. For this particular issue, Robinhood sided with the hedge funds and the powerful players of Wall Street. Robinhood restricted the trade of many stocks that were bet against by hedge funds, including GameStop. This prevented Reddit Investors from selling the stock when it was at its highest point, which means that these traders were unable to make a profit. However, as for the hedge funds, they are slowly regaining their lost profits.
The debates about legality have already started circling, both in society and in government. On one hand, market manipulation is not legal and the actions of the Reddit Investors do not abide by the regulations of the government. However, market manipulation is a common tactic that is also used by large hedge funds. Although betting against a stock might help hedge funds earn a profit, it still takes advantage of both the business that is declining in value as well as the stock market.
The verdict in this debate should be seen as a reflection on our society and government. This entire controversy boils down to a debate on ethics. When the underdog wins, can we accept the flaws in our system and work to fix the status quo, or will we allow those with power to continue exploiting these loopholes?