Making sense of the markets this week: February 1, 2021 | MoneySense

Redditors took on hedge funds—and won!

Not to be outdone, the year 2021 turns to 2020 and says “hold my beer.” 

Just when you thought that things couldn’t get any loopier, along comes the story of the week: An army of retail investors organized on Reddit to force hedge funds out of their market positions using trades on GameStop stock (GME).

Here’s the backstory. As you may know, Reddit is an online chat platform with a strong bent to personal finance and investing topics. The topics are organized in forums. One such forum is WallStreetBets, now known as WSB for short. Many members of WSB decided to take on hedge funds that will bet against stocks—it’s calling shorting. When you short a stock you profit when the stock price goes down. 

Here’s the shorting process simplified (there’s also a good explanation and graphic in this post):

  1. Borrow stock shares from a broker/dealer. 
  2. Sell that stock to another investor. 
  3. Wait for the price to fall. 
  4. Buy the same amount of shares borrowed at the lower price. 
  5. Return the shares to the broker. 
  6. Pocket the difference, subtracting commissions.  

Some hedge funds specialize in organizing very active campaigns designed to drive down share prices of the companies that they short. How? By releasing mountains of research and producing elaborate presentations in an attempt to convince the market that a stock might be mispriced, or that the company is in serious trouble. If they can drive down the stock price, the hedge funds making those short bets will prosper. 

Here’s a link to The Motley Fool’s Mat Litalien reporting on the hedge fund Citron Capital, which organized an aggressive short campaign against Canada’s market darling Shopify. Citron is one of the hedge funds that had a significant short position in GameStop, the company at the centre of a dangerous stock market game that’s taken over headlines this past week.

A few other hedge funds, including Melvin Capital, have been aggressively shorting GameStop. Things got, shall we say, interesting, when Redditors rallied around the GameStop stock, driving up the price. As a result, GameStop, which entered 2021 trading in the $17 range, closed above $325 on Wed., Jan, 27. On Thursday the stock fell to $236 as the Robinhood trading app restricted the selling of GameStop stock. TD Ameritrade, followed suit limiting trading on the stock. 

On Friday, the Redditors were allowed to buy again, sending the stock to over $390 by the morning of Jan. 29. 

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