To make sure you never miss out on your favourite NEW stories, we're happy to send you some reminders

Click 'OK' then 'Allow' to enable notifications

WTF Is Going On With GameStop, Reddit, And The Hedge Funds

WTF Is Going On With GameStop, Reddit, And The Hedge Funds

Stocks are complex - let's learn about them together

Imogen Mellor

Imogen Mellor

This piece is a collaborative effort between Julian Benson and Imogen Mellor because, well, two games journalists explaining the stock market is obviously better than one.

Right, so stocks, eh? We thought that Animal Crossing's turnip prices were complex but, boy, is the real stock market an incredibly complex system of numbers, software, and businesses. Right now everyone is talking about one situation in particular - the issue of Wall Street versus Reddit. And without knowledge of how the stock market works, it's a baffling story to try and make sense of. So here we are, trying to make sense of it for you. You're welcome in advance.

Why GameStop?

GameStop: if you're in America, you'll know the brand well, but otherwise, it's a brick and mortar set of shops that buy and sell video games, hardware and gaming merch. Think of CEX or GAME as an equivalent here in the UK. As game sales have become more digital, GameStop has seen a steep decline in its business and, consequently, its share value. Back in January 2016 a share of GameStop stock would set you back just over $25, but by August 2020 that had slumped to less than $5. While the company tried to move with the times, shifting more of its business online, the impact of the pandemic on high street shops has been another blow to the business.

No, But Seriously: Why GameStop?

Look, that steady decline is what made GameStop stock (GME) attractive to a particular kind of investor tactic: shorting. It works by investors borrowing shares of a company, agreeing to return the shares to the owner. The investor then immediately sells the share at its current value and then waits for the stock price to fall; they then buy back the share at a reduced price and give it back to the owner they borrowed it from in the first place. The owner keeps their stock and the investor pockets the difference between the price they sold the share at and the lower price they bought it back at. For example, they borrow stock and they sell it for £100, then buy it back at £75 a month down the line, before returning the stock to the original owner, closing the short and in the process making £25. Simple, right?

This is what a group of hedge funds did with GameStop. They were so confident in the payoff of the short that they talked about their plans publicly. That was their mistake, because Redditors spotted an opportunity.

Enter WallStreetBets, a subreddit that keeps an eye on the stock market - not professionally by any capacity, but sort of as a hobby. They realise what's going to happen with hedge funds shorting this stock and realise they can both make money and mess with hedge funds at the same time.

When the hedge funds borrowed GME shares and sold them, part of their deal with the stock's owners was that they would return the shares no matter the cost. So what WallStreetBets realised was that if they bought up GME stock, as much as they could afford while it was cheap, then its value would rocket because it was in such high demand and the hedge funds would have no choice but to buy it from them at its much-inflated price, or they'd break their contracts with the big banks who had lent them the shares they shorted.

GME stock started increasing in price at the end of 2020. Going from $4 in July last year, hitting $20 on January 12, $75 on January 25, and peaking at $470 on January 28. It was getting to the point that the stocks hedge funds had shorted were so much more expensive than the price they sold them that to buy them all back would cost them millions, even billions. The biggest name on the hedge fund side, Melvin Capital, was allegedly on the hook for $13bn at one point, facing bankruptcy - two other hedge funds stepped to lend it money to keep it from collapse.

Complicating matters is that there isn't a clear end in sight. While some Redditors are in this to make money, seeing an opportunity to pump up the value of a cheap stock and sell it to a hedge fund desperate to buy shares before its short deadline hits, others are seeing this as an opportunity to make hedge funds hurt. If they hold onto these shares, refusing to sell, even when their value has increased a hundred times over, some of the hedge funds will be unable to buy back the shares they borrowed and will default on their contracts, potentially bankrupting them. If you're not a fan of Wall Street this is a way to hit back at them playing their own game.

And one more complexity for your troubles - this isn't as simple as Reddit vs Wall Street. It appears there are hedge funds buying up GME stock, too, looking to take advantage of the same short squeeze as the redditors.

So How Does Robinhood Fit Into All This?

Well, Robinhood (not Robin Hood, scourge of the Sheriff of Nottingham) is an app that, in their words, "democratises" the stock market. Traditionally, there can be a lot of fees involved in making trades on the stock market - the sorts of fees that mean it only makes sense to buy and sell shares in very large numbers - but Robinhood does away with all that allowing normal people (i.e. not professional stock traders) to easily buy and sell shares in small numbers. You don't even pay an upfront cost to Robinhood either, which is nice.

Robinhood is able to offer all this for free because it covers its costs by selling data on its users trading decisions to investment firms, so they can change their tactics in milliseconds to match commercial trends. But back to the main issue: Robinhood is what many Redditors used to obtain GME shares. At least, it was.

On Thursday, after GME stock hit its high of $470, Robinhood blocked its users from buying any more shares in the company. Not just in GME but other businesses that WallStreetBets had identified as potential short squeezes - such as cinema chain AMC, and mobile phone manufacturers Nokia and BlackBerry.

Robinhood users could still sell their shares - and many did, seeing the market turn against them, and this sent the value of GME shares plummeting. At one point it lost more than $200 in value in less than 30 minutes.

Later in the day Robinhood went even further, apparently selling users' GME stock without their permission - again, further driving down the value of GME stock. Those users are still getting the money from those sales, but for the Reddit users holding onto shares for reasons other than that, it's making people really angry.

Why Did Robinhood Block Its Own Users?

As with everything in this saga, the reasons for Robinhood's actions are complicated and not clearly known. One reason being floated is that Robinhood's under pressure from one of its biggest clients, a hedge fund called Citadel. What's Citadel's interest in all this? Well, it's one of the firms that bailed out Melvin Capital when it was in danger of bankruptcy.

Though, another reason could be that it is genuinely acting to protect its users. While many people buying GME stock may be doing it to stick it to the hedge funds, there are also people in there who are wanting to drive up the value of GME so they can sell it and make bank. Whatever the motivations and circumstances that created this situation, this is a classic example of a pump and dump. For people buying up GME stock and not selling it while its value is high, they are on the line to lose their money. Some may be happy with that, buying the stock purely for ideological reasons, but others will be doing it because they think they're getting in while the value is rocketing, when in fact it's potentially about to crash.

What Now?

Naturally, all this activity has gained a lot of attention. Not just on Reddit and Twitter where the meme game has been extremely strong.

Yesterday saw a number of US politicians saying that the matter would be investigated. Surprisingly, this actually brought Democrats and Republicans together, with both Alexandria Ocasio-Cortez and Ted Cruz condemning Robinhood's behaviour. AOC and other Democrats have called for a hearing on the events to work why Robinhood acted the way it did.

Robinhood users, meanwhile, have already started a class-action lawsuit against the app. WallStreetBets is now under scrutiny from the platforms it appears on with its Discord being deleted for bigoted messages on that platform, and more.

And the story developed even while we were writing this explainer, with GME stock sales and purchases being halted temporarily. Though, that's fairly usual when a stock is particularly volatile.

It's a mess, a serious one at that, and it raises a really important question about Wall Street, the free market, and how is it that this situation seems to have more accountability than the financial crash of 2007-2008. Lawsuits are already being discussed and Wall Street, despite having the ability to trade however they want (within legal bounds), are now upset that a layman can do the same, and have used that to their advantage. How is it that when the stock market benefits the ordinary person that there is talk of new litigation? How is it that when normal people take things into their own hands that apps are trying to prevent them from using the tools still available to Wall Street workers?

Featured Image Credit: Paramount Pictures / Google

Topics: gamestop, News, guide