A new Reddit community called WallStreetBets is bringing some notable financial experts to their knees and causing chaos in the general market. The anonymous users have combined forces to target heavily shorted stocks.
It is a commonplace trading tactic to bet against shares of companies you have doubts about. To “sell short” you must borrow shares from your broker, which they procure on the open market. You then sell those securities to others with the hope that the price will fall and you can buy them back at a lower price. You then return the shares you borrowed to your broker and pocket the difference.
If the price goes up though, you lose money as you are buying back those borrowed shares at a higher price than what you sold them to others for. Because there is technically no limit to how high a stock price can go, brokers require market participants who sell short to maintain a cash buffer so it isn’t on the hook if the trade gets away from you. The buffer is a certain percentage of the overall position and is determined by expected volatility.
The WallStreetBets community is forcing shorts to unwind their positions all at once as their coordinated purchases drive shares initially higher. That is causing incredible price swings. GameStop, a struggling entertainment retailer, has seen its stock price go from $18.84 at close on December 31st to almost $300 by Wednesday morning. It is rising by as much as 100% a day. Several hedge funds have attempted to take the other side of the short squeeze only to take a bath.
Volume is soaring as brokers force shorts to liquidate other positions they have to make good on their losing bets. The unwind is causing the overall market to drop as favorites like big tech companies are sold. The system is strained enough that it is difficult for self-directed traders to access services like TD Ameritrade or Charles Schwab.