What the Hell Happened With Gamestop?

Most people weren’t expecting Gamestop to be the first big stock story of 2021, but that’s exactly what happened — and it’s all thanks to a group of people on Reddit. With the explosion of day trading over the past few months, a lot of discussions about stocks and individual investing have been taking place in unconventional locations. One of those is Reddit, which is a lot like a giant chat room or discussion board, where anyone and everyone can post about pretty much anything at all. There are several subreddits on the site, including those that talk about investing and other stock-related information.

The biggest thing the trading world learned with the Gamestop stock issue is that the “little guy” can be very influential when it comes to the value of a stock. Some individual day traders trade a lot, and they do it to the frequent annoyance of big-time traders and institutions that are often used to process trades and address market fluctuations. In short, no one expected a group of small-time day traders on Reddit to have a significant impact on the stock price of a company. Yet that’s the story in a nutshell. For a better understanding of what happened and why it’s so significant, you have to dig into the details.

WallStreetBets and the Rise in Gamestop Stock Price

The subreddit r/WallStreetBets has plenty of traders who use it. When they all get together and focus on a company, they can be very powerful. A small army of them started trading Gamestop stock, and it snowballed into a massive rise in the company’s stock value over just a few short days. The extreme and rapid change led to a forced halt in trading and caused a lot of headaches for short-sellers who were betting against the stock. They were looking for the price to fall, and it didn’t. It just kept rising, instead. But how and why did all of this occur? It’s a surprising tale, but one that could have, theoretically, happened with just about any company.

It started when a trader on the r/WallStreetBets subreddit decided they believed that Gamestop stock was worth more than the stock was currently selling or trading for. They saw it as a value investment and made a case for purchasing the stock. The argument was that it was undervalued now, and if people bought it at a lower price it would make them money when it was properly valued later. At that time, it would be trading or selling at a higher price, so people who already had shares of it could make money. It’s the time-honored “buy low, sell high” philosophy that is always at the heart of stock trading.

People on the subreddit agreed with the person’s argument and the idea that Gamestop was undervalued and was a good investment if it were purchased at the current time and the current price. That wouldn’t have necessarily been an issue, but at the same time, there was a group of hedge fund managers who had billions of dollars they were managing as investments. These managers believed that the Gamestop stock was going to drop instead of rising, so they were selling it short. That would not have been an issue, either, if it wasn’t for all the people on the r/WallStreetBets subreddit who suddenly decided to buy Gamestop stock.

Why Did Gamestop Stock Appear Valuable?

One of the most interesting parts of this story is why it happened in the first place. The steps that occurred can be explained, but what made that first-day trader tell a subreddit full of people that they thought Gamestop stock was undervalued? As it turns out, the reasoning is pretty simple. The idea that Gamestop stock wasn’t trading where it should be isn’t a new one. It’s been floating around on Reddit for a couple of years, on and off. That’s because the company was undergoing changes even back then, and it continues to change. Those changes haven’t all been positive, but the overall direction of the company appears to be moving in a way that investors feel good about.

With so many malls closing up and the pandemic in full swing, the idea that Gamestop was going to prosper may seem strange. But it was revealed late last year that Ryan Cohen, who is co-founder of the online pet company Chewy, had a big stake in the company. He was recently added to the board of Gamestop, which was perceived as a positive move for the company. Between that and the idea that the stock was already heavily shorted, day traders started to become more insistent that the company’s stock wasn’t trading at a value that was realistic for what it was worth. There were also rumors that the company was going to go digital, which would have been a huge change and a way to stay relevant, as well.

If the company does go digital, it may see its stock price go up even further. But many traders have already sold their stock or are considering selling it because the stock price is starting to drop again. They don’t want to get caught with a lot of shares of stock that’s dropping in price when they could sell those shares at a very high price and make a large profit. The original day trader on Reddit has commented that he holds $33 million in Gamestop stock. It’s hard to say whether there’s any accuracy to that statement, but it’s clear that a lot of people made money when the stock took off so strongly.

With its original price of $17 per share, 100 shares would have cost $1,700. Sold at its peak of around $347 per share, that $1,700 would have become $34,700. If anyone bought thousands of shares when the price was very low and sold when it was at its peak, the potential exists to have made millions in just a few weeks. Whether day traders will continue to try to do this with other stocks remains to be seen, but those who study the market agree that fluctuations at this level are very rare and not likely to happen often. Even if a large group of people decides to buy stock in a company, it takes a lot to drive prices up at the level and speed that was seen with the Gamestop stock.

The Tug of War on Wall Street

The Reddit day traders buying Gamestop stock were doing exactly the opposite of what the hedge fund managers were trying to accomplish. So a tug of war began. That led to a nearly meteoric rise in the price of Gamestop stock, and — at least for a little while — it appeared that a group of day traders on Reddit were more powerful than the traditional investment companies. The rising prices put increasing pressure on the short-sellers. Why? Because short-selling involves selling stock that you don’t own. You borrow it from a stockbroker and try to sell it in a way that makes you a profit.

For example, if you borrow a share of Gamestop stock when it’s trading at $20, but you think it will soon fall to $10 a share, you can sell the share you borrowed to someone at the $20 price. Then you wait for the price to drop. When it drops to the $10 you expected you buy it, and then give it back to the broker you borrowed it from. Since you borrowed it for nothing, sold it for $20, and bought it for $10 to return to the broker, you made $10 on the deal. Do that enough times, with enough shares of stock, and you can make a lot of money in a very short period.

Except that wasn’t what happened when Reddit day traders continued to drive up the stock price. Instead, short-sellers became increasingly frustrated and continued to lose money, because the Gamestop stock price didn’t fall as they expected it to. There are a couple of options for hedge fund managers and others who buy and try to short sell. They can provide collateral to the broker they borrowed the stock from and hang onto the stock, or they can sell at a loss and return the stocks to the broker. Either way, they aren’t making any money that day.

Gamestop’s stocks started in 2021 at around $17 a share. As of January 27th, that same share of stock was trading at around $347. That’s a massive difference and one that’s not normally seen in the market. Sure, stocks rise and fall. Sometimes it’s unexpected, and sometimes the amount of the change is more than would be typical. But there aren’t very many times that something like Gamestop’s stock price rise has occurred — and especially not due to a group of day traders on an internet discussion forum. While professional investors may not like the idea, it’s becoming increasingly easy for individuals and day traders to cause market fluctuations.

What’s the True Value of Gamestop Now?

No one knows the current, true value of Gamestop stock. But the most important point is that it doesn’t matter who’s right or wrong. All that matters is the stock is trading vastly higher than it was before, and anyone who wants to trade that stock simply has to deal with the current price. The markets can be erratic and irrational at times, and there’s no way to know how long they’ll stay that way. The Reddit day traders could be wrong, and the price of the stock could eventually fall dramatically. Even if that’s the case, though, the rise in Gamestop’s stock price has already caused big losses for some of the more traditional hedge funds.

One of them, Melvin Capital, lost around 30 percent of its value. Of course, it also just received a $2.75 billion bailout, so it’s not going to be taken down by day trading individuals on a subreddit. Still, the company discovered that the “little guy” can affect the way it does business and its opportunity for loss, and that’s something that hedge fund and short-selling companies will need to be more careful of in the future. Now that they know about it, they can be watching out for the problems these kinds of fluctuations can bring to their bottom line.

Gamestop stock prices have fallen a lot since their late January peak. As of February 10, 2021, the stock closed at $50 per share. That’s still well up from its $17 original price, but likely more realistic than the $347 of a few weeks ago. Those who sold when the stock price was high made a lot of money. Those who still hold the stock made less, but still, probably have a good investment. The stock price may hold at a steadier number now, simply because it’s had a chance to level out, and most of the frenzy surrounding it has died down. But the bottom line is that day traders, hedge fund managers, and others who play the odds simply don’t yet know what will happen with the price of the stock.

It may return to its previous low levels, rise again as it did just a few short weeks ago, or hold steady where it is now. Either way, the potential still exists for a snowball effect like the one seen previously. Day traders who drove up the price of the stock likely won’t stop trading. Some of them make their living this way, by trading various stocks throughout the day, every day. There’s real money to be made with that type of life, but things generally don’t happen the way they did with Gamestop’s stock prices. Among the things that happened because of the soaring stock price was the interest that came from people who wouldn’t have bothered with Gamestop stock otherwise.

Venture capitalist Chamath Palihapitiya tweeted about Gamestop stock purchases, as did Elon Musk. The Securities and Exchange Commission even took note of what was happening and started monitoring the volatility in the market. Rapid losses can happen to investors when stocks swing wildly, and that has a way of undermining confidence in the market. Because of that, the SEC wanted to make sure the market itself wasn’t going to start experiencing large fluctuations due to what was happening with the Gamestop stock. Fortunately, the overall market remained relatively calm and there weren’t any large disruptions.

What Kind of Fallout Can Investors Expect?

One of the biggest issues surrounding the Gamestop stock issue is how it may shape what happens with trading in the future. Companies like Robinhood stopped allowing trading of the stock when it started to rise the way it did, and a class-action suit has been filed over the way the platform restricted trades. While Gamestop’s stock price rise was completed unprecedented and unexpected, it also indicated that many stock trading platforms aren’t set up to handle these kinds of fluctuations and changes. That could lead to a restructuring of these platforms, and may even lead to some of them closing up or changing how they do business.

It’s also likely that what happened with Gamestop’s stock will happen with other companies now that it’s come to light in the public eye. It stayed in the financial world for a while, but now it’s mainstream news. That means others will be trying to replicate what happened by choosing other companies and driving up their stock, as well. It’s not illegal, and it can make people who do it well very rich. Since that’s the case, it’s not surprising that more people will try it. Only time will tell how Gamestop stock continues to perform, and whether other companies will have a similar experience when a day trader with an audience decides a stock is worth more than its current market valuation.

Part of the interest in the Gamestop stock fiasco is the money and the way a group of individuals seemingly had so much control over something so significant. But part of the interest is also in the level of silliness that came along with it. A group of day traders on a subreddit listened to one person, started buying stocks, and essentially went viral for what they were doing. That led a lot of other people to do the same thing and drove up prices. In the meantime, a lot of serious professionals who manage hedge funds and short-selling operations were quietly pulling their hair out because they were losing significant amounts of money very quickly.

It would feel fictional if it hadn’t occurred in plain sight where anyone who follows stocks could see it taking place in real-time. Now that the r/WallStreetBets subreddit has shown what its members can do, it’s likely that those same-day traders will be looking for more stocks that are being shorted. When they find them, they may be able to replicate their success and the money and notoriety it brought them. This likely isn’t over, and it’s also likely that the subreddit has a lot of new members just looking to make their fortune in the markets. Whether they’ll have success remains to be seen, but one thing is for certain. Now that hedge fund managers have seen what individual day traders can do when they band together they’ll be watching their short-selling activities much more closely in the future.

Angel investor and Entrepreneur. Blockchain, Crypto, and a little bit of everything in between. London, UK