Right now, one of the most omnipresent stories in finance is about a short squeeze involving a once obscure (but wealthy) hedge fund, Melvin Capital, and a very large cohort of retail investors on Reddit (Wallstreetbets). The story, if you haven’t heard it, is simple; Melvin Capital initiated a short position on Gamestop (GME), and Citron Research voiced support of the position. Some WallStreetBets users went long the stock (or were already long), and a meme created momentum in which more investors got together to go long GME in an attempt to squeeze Melvin’s short position.
Whether this has worked or not is unclear; Melvin has received additional investment from other hedge funds, and they have not announced whether they have covered their short or not. Meanwhile, on Monday January 25 the stock skyrocketed to $150 only to fall to less than $80, with so much volatility and price uncertainty that market makers were scrambling in the options market during the pandemonium. While Wall Street trading is not as chaotic and exciting as it was in the pre-internet days of actual trading pit floors, a day like Monday comes pretty close.
At the core of this battle is the concept of a short squeeze, which is a simple and very important concept for Wall Street analysts, investors, and participants to understand. Shorting a stock is borrowing it in the short term, effectively creating a market position where you make more money as the stock goes down. But there are a variety of restraints on how much one can short a stock, and if some or all of those limits are reached, a fund will need to cover its short by buying the stock. People who long the stock can force whoever is short the stock to cover by driving the price high enough that it triggers those restraints.
This is, in effect, what WallStreetBets is trying to do with Melvin Capital, albeit there is little clarity yet on how successful they are (later this week when short interest data is published there will be more information on the matter, which will likely cause aggressive moves in the stock one way or the other).
What is interesting about this dynamic is that it is a purely technical movement in which retail investors are trying to best hedge funds at the game of shorting stocks. It is very much the story of barbarians at the gate–which is itself quite interesting, because that was the narrative pushed decades ago when hedge funds first reached prominence and began demanding executive changes at corporations they invested in. Once the barbarians, now hedge funds are controlling the gate.
How this will all shake out is anyone’s guess, but it appears clear that, after years of gaining prominence and notoriety, groups of retail investors are banding together in an effort to influence markets; whether they can succeed remains to be seen.