There is no turning left or right today without hearing about the GameStop stock and its crazy rally over the past three days. What emerged in a subreddit by Wall Street Bets is now reported not only on financial news outlets but also in mainstream news coverage and even my online bank has a headline about this on its login page.

If you are new to the stock market or at least to its more risky assets, you may not understand what's going on. Let me try to put the whole story in a simple perspective from someone who only recently learned about this himself. Therefore some details might not be 100% accurate, but I'm sure the point will get across.

Hedgefonds and their short bets

Huge Hedgefonds who have been gambling on Wall Street for decades have lately grown especially fond of what is called "short bets". A short position means you believe that a stock will decline in value and therefore sell it. With the short bets the Hedgefonds tried to make money out of falling stocks in the following matter:

1. They would approach someone who owned the stock and ask them to borrow it to them for an interest rate. Let's say 1% pa just to have something to work with.
2. The stock might be worth 10 USD at the time, but the Hedgefond is certain that it will drop further and sells the borrowed stock. As Hedgefonds operate with huge market volumes, this action in itself often triggers the price to decline rapidly as other investors follow the example.
3. When the stock is cheaper, let's say a week later it's at 5 USD. They buy it back for half price and return it to its owner.
4. For the week they pay the original owner an interest of 0.0014 USD (assuming the stock declined linearly with a mean value of 7.5 USD over the time).

What could go wrong?

Note that the short bet strategy explained above is a great way to make easy money, while the market is following the trend you are anticipating or even better, the trend that you are setting with the mere volume that you handle.

1. Imagine the example above, but instead of declining to 5 USD, the stock climbs to 20 USD.
2. Again assuming a linearly rise of price, the interest for the week would now be 0.003 USD
3. The Hedgefond would be forced to pay this higher interest rate and could not exit out of the position, because returning the stocks would mean buying them at a higher price then they sold it for. Usually they would just sit out the situation, pay the interest, and wait to the price to decline and close the short position.

The Squeeze

A so-called short squeeze is a special situation where the Hedgefonds gave the ability to manipulate the market out of their hands by selling so much borrowed stock that the amount of stock remaining liquid on the market (stock that people set up for sale and are not sitting on) became so small, that a few other parties buying in can drive up the prize in crazy heights due to the relatively high demand but low availability. The problem with this?

1. Assume the price does not go up to 20 USD but to 200 USD. The interest the Hedgefond has to pay for the week now equals 0.17 USD. While they have a lot of money sustaining these payments over a long time, while they only planned with 0.0014 USD, can make the Hedgefond run out of liquidity. Especially when this high level of price is maintained over a longer period of time.
2. The Hedgefond may therefore be forced to buy the stock at an "overpriced" rate just to return it to its original owner and get out of the interest obligation.
3. Thus the Hedgefond creates new demand for the stock and the price drives even higher.
4. This spiral could continue until the Hedgefond closed all of its short positions.

What is so special this time?

While short-squeezes have occured before, they are rare and always involved big players screwing over other big players. This time...

1. The amount of stock remaining on the market was not purchased by big players, but by a mass of retail investors who organized themselves through Reddit and social media.
2. The situation is especially bad for Hedgefonds with GameStop as they have loaned and sold 140% of all stocks available. Even if they bought back every single paper, they could not close all of their shorts.
3. Investors are not just targeting one stock. While GameStop has become the iconic symbol, the short-squeeze is also occurring on AMC Entertainment, Bed Bath and Beyond and many other companies who saw their price suffer under the pandemic and caused Hedgefonds to bet against them.
4. The whole thing started with some internet memes and seems to be not only an investment for those participating, but also a joke and a game at the same time. With their self-ironic way of uncovering what is going wrong with the financial system, they seem to have pumped the meme Cryptocurrency DOGEcoin along the way.

Can I still get in on this?

The whole movement lives from the idea that the investors hold on to their positions rather than selling them. Only this way, the price can be maintained on a high level long enough to make the Hedgefonds feel the pain of the high interest rates. Therefore, this could go on a couple of days or even weeks longer with explosive higher highs on the horizon once the spiral starts to turn. The community has formed the term "Diamond Hands" for their cause, which is a metaphor for holding on to the stock with hands hardened like a diamond.

We do however, not know, if the community behind the movement really has the willpower and nerve to pull this through. If too many "Paper Hands" sell out and take their profit, the stocks, most of which valued low for a reason, will crash to the level they came from or even below it.

As always, it's all about the right timing. If you want to get in with the flow without becoming a stock market trader, why not buy a little bit of DOGE on Binance to see what happens?

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Disclaimer: No financial advice included in this article. Just my personal experience. Do your own research!

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Images courtesy of Unsplash.com

This is a re-published post from my account on the HIVE blockchain.