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explainer

It’s been a dizzying week. The roller coaster for stocks such as GameStop and BlackBerry has moved so quickly that it’s tricky to follow what’s going on – especially for those who don’t have financial backgrounds. What follows is an explainer:

What started this?

GameStop (GME-N) is a U.S. retailer that sells video games, mostly in malls. The company had been struggling because of a growing acceptance of e-commerce, and because mall traffic has dropped during the pandemic.

Last summer, Ryan Cohen, who grew and then sold online pet-food retailer Chewy, bought 13 per cent of GameStop and hoped to help management pivot into e-commerce. The stock quadrupled in four months, and that attracted short-sellers.

What are short-sellers?

Plain and simple, they are investors who bet against a stock, hoping the price will fall.

To do this, they borrow shares from someone who plans to stay invested for a long time, and then they sell the shares. After the stock price falls, they repurchase the shares at a lower price and return them to the lender. In doing so, they pocket the difference between the money made from selling the shares at, say, $50 each, and the price paid to repurchase them, perhaps $25 each.

This is common behaviour, which is why some hedge funds decided they would “short” GameStop’s stock – that is, bet that its price would fall.

What are hedge funds?

Money managers with a fancy name, that’s all. Back in the day, hedge funds deployed a specific investing strategy designed to hedge their trading risks. But over time, these funds attracted so much money, and the broader industry evolved so much, that they are now little more than ordinary money managers that charge very expensive fees.

Yet they stand out because they tend to market themselves to the ultra-rich, who can pay the exorbitant fees. A number of hedge-fund managers also have a history of flashy lifestyles.

Which made them prime targets for Wall Street Bets.

What is Wall Street Bets?

A portal on Reddit, which is an internet forum where people anonymously discuss everything and anything imaginable. Wall Street Bets – written as r/wallstreetbets – is normally where people discuss their investing ideas, but last week some users decided to come together and stick it to the hedge funds who had bet against GameStop by starting a short squeeze.

What is a short squeeze?

A fancy name for buying shares. To make money, short-sellers need the price to fall. If it rises, they have to repurchase the shares they borrowed and then sold for a higher price, which will make them lose money.

This squeeze happens often, which is why short-selling can be risky. What made GameStop’s situation stand out was the use of stock options.

What are options?

A bet on the price of a stock by a certain date. So if GameStop is trading at $10 per share, you can pay a small sum, maybe $1 per share, to be able to purchase shares for $15 each until March 31. If it doesn’t hit that price, you lose the small sum. If it trades to $30, you buy the stock for $15 each and sell at the market price.

In recent years, options have exploded in popularity on day-trading platforms provided by companies such as Charles Schwab, Interactive Brokers and Robinhood. And they were heavily purchased to send GameStop’s share price higher.

But why did GameStop’s share price skyrocket?

Because everyone piled in. GameStop wasn’t a popular stock before all of this, and options can be much more volatile than stocks themselves, so the sudden attention from the growing mob of retail investors made its price go haywire. The early gains then attracted more people who read about the phenomenon and wanted to gamble for fun.

After GameStop’s shares started to soar, the early investors who wanted to stick it to hedge funds decided to squeeze short-sellers betting against other stocks, and BlackBerry Ltd. happened to be one of them.

What caused the losses on Thursday?

When mob mentality takes over, it’s tough to determine the exact reasons for trading swings. Sometimes, traders who made big profits riding the wave simply decide to cash out, prompting others to do the same, and then the selling sends the share price spiralling.

However, there was also a major development Thursday: Two trading platforms, Interactive Brokers and Robinhood, changed their rules to prevent customers from buying shares in a number of companies, including GameStop and BlackBerry (BB-T) (anyone who owned the stocks already would still be able to sell).

Why would they restrict trading?

We don’t have a final answer yet, but trading platforms often allow their users to borrow money to invest. When share prices swing so wildly, the loans can become worthless in minutes. So they probably want to protect themselves in the event that many of the loans aren’t paid back.

Does this spell a market revolution?

Not necessarily. Some of the Wall Street Bets crowd like to say they are taking on the establishment, but for all we know, the establishment has already smartened up and offset their original investments that are being attacked.

And with so much disinformation on the internet, it’s even possible hedge funds are now posing as Reddit users to pump additional stocks they’ve invested in.

Is the entire stock market at risk of mob mentality?

It’s possible. Market integrity, as it’s known, is something regulators have to take seriously. If too many people lose faith in the market, they could stop investing, and that would prevent companies from selling shares to fund their growth.

But we’re far from that. So far, these are pockets of volatility. GameStop and BlackBerry both lost more than 40 per cent Thursday, yet the S&P 500 gained 1 per cent.

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