What is a Short Squeeze? The Gamestop Short Squeeze

How did an almost bankrupt company like Gamestop ended up rising to almost 6600% in less than a year? Its part fundamentals and its part a perfect setup of people trying to get out but the exit is small.

Before I can explain what is a short squeeze, let me first explain what is shorting and how it is done.

Shorting

Shorting in the most simplistic way to describe it, is betting that something is going to go down. If the stock you “shorted” went down, you will make money. If it goes up, you will lose money. Its kind of the inverse of buying (long).

What’s Happening Underneath?

To execute a “short”, you will need to “borrow” shares. After you borrow it, you immediately sell it. So you liquidated a stock that you don’t own, you just borrowed it. Let’s say you have Meralco at 300 and you shorted it at 300. It means, you borrowed shares of Meralco then immediately sold it. Now you have 300 in cash.

The reason you make money if the stock go down, is if the Meralco shares you borrowed-sold, went down, example, to 250. If you want to get out of that short position (cover), you just need to buy the shares current price of 250, and return your borrowed share and you keep the 50. This is how you make money shorting.

Its all complicated and all, but its all happening underneath and the brokers are incharge of doing it for you.

What Happens if It Goes Against You?

What happens if your stock went up? Well that’s the same thing as when your stock went down. You lose money. But the bad thing about shorting is, your loss is infinity. While a long stock is 0.

A stock can go down to 0. But a stock can go up to infinity. Therefore shorting expose you to infinite losses.

Back to Gamestop

Now that we know what shorting is, and what is happening underneath, let’s investigate what happened to Gamestop short squeeze.

It started last year when Gamestop is almost bankrupt. Some investors are betting that the stock will go bust so they shorted. Some people invested because the release of PS5 would help turn around the company.

PS5 came about and its sold out everywhere. Giving confidence to the bullish investors about its prospects. The stock went from $5 to $20. The shorts (the people who short stocks) thinks that the rally to $20 is temporary and Gamestop will still go bust after the PS5 demand subsides. Now, all of the big funds in Wallstreet, piled unto the short side of Gamestop. Almost the same (if not more) than the amount of the float.

What this means is, the short sellers are borrowing more shares, than the actual number of shares in the market.

Now this is where the squeeze is setup. To exit a short position, you need to “buy” a share. Just like when you buy a stock in your portfolio, you need to sell in order to exit. The reverse is for short selling, the exit is a “buy”.

Now comes the Redditors

The reddit community who are well versed in the financial markets wants to take out the funds shorted in Gamestop by orchestrating a short squeeze. If they buy all the shares in Gamestop, the price would rise, the short sellers would get hurt. And if the redditors won’t sell their shares, how would the short sellers get out of their position if there aren’t any shares available? Therefore, a squeeze. They have no choice but to “cut loss” and a short sellers’ exit is buying. So they are forced to buy at a higher and higher price just so they could minimize the loss. But each time they cutloss, the stock will rise, because their exit is a buy order, furthering the losses.

On top of that, more and more redditors are buying the shares, so more funds lose billions, they need to cutloss (by buying) but there are few shares available. Its an endless loop. That’s why its a squeeze. Too many people shorted, but the exit is small (few shares). And that’s why some billionaire fund managers who are short in the stock are crying and wants people jailed. But on the other hand, people who sold which isn’t theirs and can’t get it back, should also get jailed right?

Now what happens if the original owners of Gamestop wants to exit their position. Those people who buys the shares of Gamestop, but was lended to the short sellers, what happens when they want their shares back so they can take profit? Where will the short sellers get their shares? Price goes up some more. Its really a squeeze.

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