MyFinancialTimes is a reader-centric site. We may receive compensation from the products and services we mention or recommend in this story, but the opinions are the author's own. Remuneration may impact where offers appear. We may not include all available products or offerings. To learn more you can visit our advertising policy and editorial policy.
Shorting a stock is a seemingly complicated tactic, but with a few cute pictures and a little bit of time, you’ll know what it is and why the GameStop saga meant big losses for those who did it.
When it comes to the stock market, there are many more complicated tactics to earning money than just buying, holding, and selling. While that may be the simplistic investment capable of insane returns, there are other short-term tactics that can make for terrific results- as long as the investment is thoroughly understood, and the investor can afford the risk.
We’ll take a close look at short selling and why it is a major risk with the potential for quick returns.
This battle is between Jimmy, the eccentric gamer, and Dale, the businessman who hasn’t touch a console since the 90s.
When Games Are Us, a popular video game store, began to report below-average sales, Dale took a bet that the company’s stock price wouldn’t do so well in the future.
So, Dale went to a brokerage that holds Games Are Us stock and asked to borrow one for a month. The broker happily agreed, and lent Dale the stock, asking if he wanted it with ketchup or mustard. Dale shook his head and headed off with his loaned stock.
Later, Dale went out to sell that borrowed stock for its market price, which was $50 a share.
Dale does this because he firmly believes that the Games Are Us stock is going to plummet. In his head, this is what will happen in a few weeks:
In his projected future, Dale buys back the stock for half price, since the stock is on a downward spiral. The poor sap who bought it for $50 would rather take the small loss, and Dale gets it back at a bargain. Dale then gives the borrowed stock back to the brokerage, pocketing the $25 he made (and makes sure to pay the broker interest and commission fees).
Short selling would have been an excellent bet, especially given that Games Are Us has been doing very poorly. It’s stock price was bound to go down! Except it didn’t.
Within the 30-day time period Dale borrowed the broker’s stock, Jimmy enlisted a bunch of his friends to bump up the price. With the use of Reddit, Jimmy got hundreds of friends to buy Games Are Us stock, shooting the price well above $100.
This isn’t good for Dale, because now he has to buy back the stock he sold before the price goes up any higher. This is called the short squeeze. Dale needs to return the loaned stock to his broker before the 30-days, so he buys it back for $100, taking the $50 loss.
Dale was sure the Games Are Us stock would go down, but he was wrong. His short selling tactic cost him $50 (in this case).
In many cases, thought, huge hedge funds short sell large amounts of stocks, pocketing a lot of ‘extra’ when the stock price goes down. When it doesn’t go down, (and in the case of GameStop it rockets to the moon), the short sellers short squeeze to prevent catastrophic losses, but end up losing out on a lot of money in order to return the borrowed stock before the deadline.
In the future, short sellers may begin to think twice before short selling a stock, in order to avoid the huge bubbles caused by Reddit hype and people like Jimmy.