SYRACUSE, N.Y. (NCC News) – GameStop stock prices dominated headlines early this year as they soared to record numbers. Despite all the news surrounding them, many are still left wondering what caused the surge.
The key to understanding what happened with GameStop is to understand the concept of short selling. While investors mostly look for a stock to rise in value, when an investor short sells, they are actually betting on the stock falling in value.
When short selling an investor borrows a stock from a lender and pays them an interest fee during the period they are borrowing it. During that time the investor sells the stock into the market, with the agreement that they will buy it back once the borrowing period is over. If the stock falls in value, they can buy it back at a lower price, ultimately making a profit. However, if the stock rises in value, they have to buy it back at the higher price and will ultimately lose money.
Jacob Graves, a retail investor, explained the concept of short selling.
“If you were to start shorting a stock when it was worth $20 a share, and say it drops to $5 a share, that would be a $15 profit for you per share,” Graves said. “If it was to go up, you know and you’re still shorting it and it goes up to $50, then it’s a loss of $30 per share.”
With short selling, over 100% of a company’s shares can be shorted at one time. This is because shares can be shorted more than once. In the case of GameStop, at their peak in January, nearly 141% of the company’s shares were being shorted.
This put the investors who were shorting the stock in a vulnerable position.
“When you short a company past 100% you don’t really have any room to go,” Graves said.
Anyone can go online and see which companies have the largest percentage of their shares being shorted. With the shorted shares over 100%, people in communities like WallStreet-Bets saw an opportunity.
If enough people purchased the stock and held onto it, they could cause the price of the stock to go up. When the price of a heavily shorted stock rises, short sellers are forced to buy their shares back to close out their positions. When this happens short sellers are not only losing money on their initial gamble, but the stock price then goes up even higher, which is known as a short squeeze.
“People just started buying,” Graves said. “People started buying stocks, and Reddit and the community started growing because people were making more money and more money, and when people are making money, everyone wants to join in.”
Graves described all the factors that led up to what happened with GameStop’s stock as a “perfect storm.” These factors all combined to push GameStop’s stock to heights it had never been before.
