If you’re someone who stays up-to-date with the global stock market news, you probably already know what I’ll be talking about. And even if you’re not one of those people, there’s a high possibility that you got to know something regarding this incident, be it on television or on social media.
During the past month the stock price of GameStop, an American brick and mortar video game shop, has been increasing and decreasing by absurd margins. And the reason for this is that the demand for the company’s stocks has been going up and down following sharp spikes. Now you might think that this is how the stock market normally functions, so where exactly is the catch? The catch is that these fluctuations in the price of the share had been initially manipulated by the big players of Wall Street and later on by the small time investors, which basically led to a hedge-fund by the name of Melvin Capital to go bankrupt.
To understand how this whole process worked, you need to make yourself familiar with the term “short selling”. Short selling is a strategy that big firms use to make quick money from the stock market.
Suppose your friend knows a guy who has 20 shoes that cost 600 BDT each. You ask your friend to be the middle-man and lend you those 20 shoes for a fixed period of time and in return you’ll give your friend 1 percent of each shoe’s price, which is 120 BDT for all the shoes. At the same time your friend also has to pay a small amount to the guy lending the shoes. Then what you do is you go to the market and sell the shoes to the store at 600 BDT each to get 12000 BDT in total. This causes the market to be manipulated and the price of the shoes to fall. Seeing this, other people with the same shoes also decide to sell off their shoes as its value in the market is gradually decreasing. Finally the price of one of these shoes drops as low as 100 BDT. Then what you do is you buy 20 of the same shoes at this price for a meager 2000 BDT and return the borrowed shoes to the guy through your friend, which leaves you with a profit of 9880 BDT.
Now instead of shoes, think of it as shares. Your friend is the broker (the guy who arranges share transactions between buyers and sellers), and the guy whose shoes you borrowed is a small time investor. And this is exactly what Melvin Capital planned to do with GameStop shares before they were stopped in their tracks by a Reddit community which goes by the name of “wallstreetbets”.
The reason behind Melvin Capital choosing GameStop shares is that GameStop hasn’t been doing well as a company in recent times, especially during the pandemic, thus people wouldn’t be surprised to see their share prices fall. This would mitigate the suspicion of foul play from people’s mind when Melvin Capital starts borrowing and selling GameStop shares.
However it didn’t go according to their plan and when the price of a GameStop share (GME) did fall to 3 dollars due to Melvin Capital selling 100% of GameStop shares, the news about the short selling plan spread on Reddit’s wallstreetbets community. This spread anger amongst the small time investors and to stop Melvin Capital’s plan from going forward the small time investors started buying back GME stocks up to a point where the price increased to a whopping 483 dollars, and left Melvin Capital in despair.
After the incident, Melvin Capital had to be bailed out by Citadel, which is another multinational hedge fund and financial services company. Citadel had to invest 2.75 billion USD in Melvin Capital to save it from bankruptcy.
Even though GME stocks were the center of attention, there were a few other company’s stocks that experienced a lesser margin of increase in its price such as AMC, BlackBerry, Nokia and etc. The reason behind these stock prices rising was the same.
Robinhood, an app that allows investors to trade shares at a zero commission rate removed the option to buy further of these companies stocks after the incident. The reason behind Robinhood favoring the Wall Street giants is that Citadel, the company which bailed out Melvin Capital, has strong ties with Robinhood.
Even though currently the stock price of GME is plummeting towards its normal price, the damage has already been incurred by Melvin Capital.
This incident was a huge victory for the small time investors and it showed the world how exactly the big firms control the market to reap off benefits for themselves.
After the short selling concept coming into light, there has been cries from different parts of the world for the stock market to be regulated more fairly, and to make it a place where small time investors don’t fall prey to the traps set up by the big giants. But only time will tell which side the stock market favors.