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An Almost Bankrupt Rising Star

Being an investor is risky. A market is volatile, constantly changing, and nobody can predict what the future holds. Even if a lot of research is done, and every financial fact is checked, no investment is guaranteed to make profit.

In general, investors buy an asset (for example a stock or a real estate) when its price is low, and then sell it when the price gets higher, which makes their investment profitable. Nevertheless, profit can also be made when prices drop. In this case, a strategy called short selling is used. It is usually executed only by hedge funds, huge companies which invest money they receive from their clients, very wealthy investors. Usually, investors can not lose more money than an amount they have invested, however, that rule does not apply to short selling, at which losses can range from a few to millions of dollars. Therefore, people who invest into hedge funds must be wealthy so that they would not get themselves into financial difficulties in a case of an enormous loss.

On the other hand, short selling can of course be very profitable. Some of the biggest Wall Street hedge funds saw a great opportunity in short-selling thousands of stocks from Gamestop, an American shop that sells games, consoles and other electronics, according to BBC News. Based on Kevin Conway’s explanation and Bob French’s article for Retirement Researcher, here is a story about this stock market phenomenon that caught the entire world’s attention.

A few months ago, Gamestop was on the edge of bankruptcy. Because of the pandemic, all its stores were closed. In addition, it has not sold its products anywhere online and therefore has not made any revenue for almost a year. Nevertheless, its stock price was still relatively high. However, based on the company’s unpromising financial records, hedge funds were pretty sure that the price will drop very soon.

What hedge funds firstly did to short-sell Gamestop’s stocks was that they borrowed them from stockholders (people who have already bought and owned those stocks), and sold them immediately for a current market price while it was still high enough. It sounds strange, but yes, on a stock market, you can sell stocks that are not even yours! That is short selling – even the name itself explains that you sell something for a short period of time.

If everything had gone in accordance with plans, hedge funds would have waited until a stock price would have dropped, and as soon as it would have, they would have bought all the stocks back and returned them to their owners. Because they would have bought the stocks for a lower price than they had sold them for, they would have made a profit. Short selling is practically always beneficial also for stock owners, as borrowers pay them a so-called commission for borrowing their stock (like you would pay an interest to a bank if it had lend you money). In this way, both lender (stock owner) and a borrower (short-seller), make a profit.

Nevertheless, in Gamestop’s story, hedge funds’ plans were spoiled by Reddit’s community of small investors, called WallStreetBets, which spotted what the funds were doing. It intentionally decided to buy as much shortly sold stocks as possible. Nobody knows for sure, why its members did that, but it is not a secret that hedge funds do not have a good reputation in public, as many people perceive them as companies that concentrate wealth in very few people’s hands, and give them too much power.

As a result of such high demand for stocks, a so-called short squeeze occurred, meaning that a price began to rise instead of fall – actually, it skyrocketed! At the end of January, at its highest point, one stock was worth almost $500 and Gamestop was listed among a market’s 500 most successfully publicly traded companies, which is insane considering that it was almost bankrupt! This was a huge problem for hedge funds, because it was time to buy the stocks back and return them to their owners, but there were practically no stocks offered on a market to do so!

In that situation, there was huge buying pressure. Hedge funds were panicking, knowing they will lose a lot of money (in fact, they lost almost three billion dollars), but they were still trying to minimize their loss by buying any Gamestop’s stock they could as soon as it was offered on a market, before the price would go even higher. But price just kept rising as both, Reddit investors and hedge funds, showed high demand when trying to purchase as many stocks as possible.

Short selling is completely legal though, so hedge funds did nothing wrong in this story. People could not believe what Robinhood, a trading app, did. It wanted to protect hedge funds, because they represent one of their main sources of income. Any time an investor on the app shows interest in a certain stock, Robinhood forwards this information to companies like hedge funds, which then buy a stock first, and then sell it to the interested investor for a ridiculously higher price.

Taking advantage of investors like that is, in my opinion, something that is morally wrong and should be forbidden, but what Robinhood did next was even more shocking. With a view to protect hedge funds, the app did not allow members of WallStreetBets community to buy Gamestop’s stocks anymore, with a view that hedge funds would have been able to buy them instead. Reddit users were still allowed to sell the stocks (which was, again, in hedge funds’ favour), but they decided to revenge by not doing so. In this way, all hedge funds’ possibilities to buy the stocks back were exhausted, and they suffered billions worth of loss anyway, even though Gamestop’s stock price eventually dropped.

However, restrictions for WallStreetBets community members were still an outrageous example of market manipulation. A stock market should always be a free market that gives everyone the same opportunities. Otherwise, smaller investors would not even stand a chance against big wealthy corporations. Robinhood should face consequences for its actions, because otherwise, manipulating with investors like that could become a regular practice. As a result, wealth would concentrate in rich people’s hands even more – well, that is actually the smallest problem. Financial markets also support millions of jobs (globally) and have a great impact on (also many international) companies’ future. So if governments do not punish such behaviour of manipulating with them, that could put markets’ stability in grave danger. In a case of a crash, like it happened with real estate market in 2008, there could be a new global financial crisis ahead of us.

Thankfully, Robinhood’s CEO had to attend a congressional hearing, on which he had have to explain the company’s actions in front of Congress members and answer their questions. There are some rumours that short selling might even become illegal because it is not even a real investment anyway and it mostly only makes rich people even richer. In addition, it is very risky.

I want to end this article with a comment that a viewer whose name I unfortunately do not remember wrote under Kevin Conway’s YouTube video: “When poor people steal from the rich, it is a crime. But when the rich steal from the poor, it is a business.”