Minnows vs. Sharks: The Case of Gamestop and Reddit

January 27, 2021 will go down in history as one of the rarest days on the Stock Market, whose final consequences are not yet known and that will surely be studied in economics schools as an example of where speculation, leverage and greed can lead; and the risk of not managing these three variables well. The story has its origin in a subgroup of the stock market of the famous Reddit portal in which a large number of small investors (minnows) managed to carry a coordinated attack against various securities funds and be able to beat them in their field, that of stock speculation.

Reddit, the beginning of everything

As I mentioned, the origin of all this is in a Reddit group where they talk about investment in the Stock Market. In this group they decide to initiate a coordinated action against the short positions of various funds against the Gamestop company (video game stores). The choice of the value is not random, Gamestop is a security that since 2014 has suffered constant falls that has taken the value from trading $ 50 in 2014 to just over $ 2,5 in 2019 and is one of the companies with the most short shares on the market, which means that if the strategy is successful, the results can be enormous.

From $ 17 to more than $ 450 in just 3 weeks

During these three weeks hundreds of thousands of small investors begin to buy shares heating up the stock value. For their part, large funds that are short and highly leveraged are seeing their positions become more and more dangerous and that the guarantees necessary to maintain these shorts are increasing. There comes a point that the pressure becomes unbearable because the losses of the large funds increase rapidly and they are forced to close positions. What is the problem? That its own purchase of shares to close its shorts causes the value to rise without stopping, which in the stock market is known as short squeeze and that is the perfect trap for shorts. The funds are caught in a devilish spiral: need to buy stocks to close their shorts but this makes the value of the stock goes up more and more which makes your losses bigger every minute.

The market goes crazy

During the day yesterday the market literally went crazy. What happened in the $ GME case ran like wildfire and this had a double effect:

• On the one hand funds had to undo positions in profitable and solid companies to obtain liquidity to close their shorts and this generated significant drops throughout the market.
• On the other hand, stocks with higher percentages of shorts began to rise as there were two buying forces: on the one hand, speculators who saw the option of repeating the $ GME case in other stocks and at the same time the funds were closing their shorts against the fear of suffering the same attack. This made companies like $ AMC $ NOK or $ FUBO go up a lot, some up to over 400%.

In short, it was the world upside down. Good stocks were declining sharply at the same time that the peas with the highest percentage of shorts were appreciating like foam. A total and unprecedented chaos.

Twitter joins the party

In case there was little mess with this whole issue, Elon Musk (CEO of Tesla) and Chamath Palihapitiya (CEO of Virgin Galactic and one of the largest investors in the market) join the party by launching two tweets that help increase the upward pressure by Gamestop.

Gamestonk !! https://t.co/RZtkDzAewJ

- Elon Musk (@elonmusk) January 26, 2021

Lots of $ GME talk sooooooo….

We bought Feb $ 115 calls on $ GME this morning.

Let's gooooooo !!!!!!!! https://t.co/XhOKL1fgKN pic.twitter.com/rbcB3Igl15

- Chamath Palihapitiya (@chamath) January 26, 2021

In Elon's case, it is not known if he actually bought shares or if it was just getting into a new puddle (one more in his long history). In Chamath's case, if he advertised his purchase and sale with a x7 of capital gains. Later he has announced that he is going to donate all the benefits of this trade. Surely he is influenced because he is going to run for Governor of California and it is not very good for a candidate to earn millions publicly speculating in the market ...

And what do the funds and the SEC do?

While all this was happening, the funds were trying to solve the situation by making public interventions on television networks in the United States. announcing that they had already closed the shorts and were protected. But anyone who has a good understanding of how the Stock Market works knew that this was not real, that they were simply trying to undermine the determination of the minority and stop the attack. The strategy did not work and the pressure did not drop but did not stop rising with a shot already above $ 340.

The SEC for its part looked Party without reacting. And this has its certain logic since what was happening was not irregular at all, it was the very operation of the stock market with its usual rules. They just paused the $ GME quote for a few minutes, but nothing relevant.

Brokers intervene

While the day continued to pass, an unusual event occurred and that in my personal opinion it should never have happened. Several brokers in the United States decide block all operations on the $ GME t $ AMC securities. This desperate move sought to save low funds and is a total violation of the rules of the game. They were preventing normal operations in the market and without any indication from the competent regulator.

Even some relevant actors request to stop the contributions so that the Large Investors can recalibrate their positions and combat these attacks. I find it incredible that they dare to ask for something like that in public and without any kind of shame.

Nasdaq CEO Suggests Halt to Trading to Allow Big Investors to 'Recalibrate Their Positions' to Combat Reddit Users https://t.co/UymE6bfuT2

- Mediaite (@Mediaite) January 27, 2021

Let's not forget that what was happening was something totally normal and that he complied with all the market rules. The price of a share is determined by those who buy and sell and no one else.

The funds receive their own medicine

But I go further, it is not that what was happening was normal but that it is a type of operation that many funds have been using for years to profit from the market. What is the sense that when a fund is strangling the minnows, nobody does anything but intervenes in the market when the opposite happens? For me none beyond that the powerful always protect each other.

The origin of all this problem is not really short positions but excessive leverage. Had those funds not been heavily leveraged, they could have closed their positions relatively acceptably. But of course, here it is not worth winning with a short position, here greed makes it necessary for you to do it leveraged with a high multiple so that the gains are huge. What it seems that they were not clear is that this leverage not only implies great potential benefits, but also a risk and possible losses also amplified.

Minority ... or maybe millennials?

An important point to note is that this attack has not really been organized by lifelong small investors but actually the investors that have organized are small young investors who are accessing the market through trading platforms like Robinhood where the trading part is mixed with a social network part. They are not investors who see the stock market as a long-term investment where you can get a return on your savings but as a playful act very similar to sports betting. They are a minority, yes, ... but not the typical minority investor that everyone has in mind.

By having this playful and addictive component, these minorities are willing to lose 100% of their investment and are capable of accept levels of risk much higher than a normal investor. And that is precisely why operating against them is a complicated task, because they are capable of maintaining a bet far beyond what is reasonable.

Can we take advantage of these opportunities?

If you have read up to this point in the article, then I think you have to be clear that getting into an operation of this type is very risky and you have much more to lose than gain. The value of $ GME is fully artificially inflated and sooner or later it will have to recover its previous values and trading in the order of $ 10-15 per share. That said, it might sound interesting to take the opportunity and go short on $ GME and wait for the drop to occur…. but by doing this you would be making exactly the same mistake as the funds and you don't know how far they will be able to carry the values ​​of the stock. On Reddit they are talking about a goal of $ 1.000, would you be able to keep those losses unsold? I already tell you that the vast majority of people would not be able to.

And all this I speak without including any kind of leverage. If you are leveraged then it is an authentic Russian roulette in a value with such great volatility and capable of going up and down 30% in a few minutes.

How will this whole war end?

The last episode of this war is not yet written. The market has not yet been officially opened in the USA and $ GME stock has already exceeded $ 500 in pre-market so anything can happen. The bet by Reddit investors to bring the value to $ 1.000 seems firm. At the moment the only thing that we are clear about is that a large group of investors spread around the world and organized through a forum have been able to put the system in check and generate some losses of more than $ 7.000 billion to several of the largest investment funds in the world. Something that a few months ago seemed totally impossible to imagine.

The only thing that I have 100% clear is that if you invest in the Stock Market you should stay as far as possible from this case and try to see the bulls of the barrier. But surely you will end up gored and beaten.