With all the attention on Gamestop in recent days, and now, silver – many people are asking, “What is a short squeeze?” and, “how are online traders driving such massive buying in the stocks or commodities they target?”
Let’s start at the beginning…
What is a short? How Does Shorting a Stock Work?
A short is a kind of trade where an investor bets on a stock going down.
If a trader thinks a stock is overvalued, the trader places a bet that the stock will head lower by shorting the stock.
To short the stock, traders borrow shares and then turn around and sell them immediately –with the intent of buying the shares back at lower prices.
If the short sellers are correct and share prices fall, then, they are able to buy the stock back at the lower price and pocket the difference.
That difference between the sell price and the buy price is the profit they make. Of course, if they’re wrong and the stock they shorted INCREASES in value, then they lose their money.
Short selling is often used as a way to hedge against downside risk in the markets or a portfolio. It helps to even out any risks in the markets and is used by institutional funds.
The risk with shorting stems from the fact that if the stock goes up instead of down, the short trader is stuck paying the difference… and when the stock keeps going up, it becomes harder and harder to get the shares, thereby driving up the price even more. THIS is the “short-squeeze” that is being referred to in the Gamestop trade.
Indeed, as hedge fund traders have sought to close out their positions, a short seller may struggle to find enough shares to buy — especially if everyone else shortly the stock is also trying to buy and the stock itself is thinly traded.
Gamestop, AMC, Robinhood and Wall Street Bets
The online community Wall Street Bets began buying up shares of Gamestop and AMC, causing massive upside in the stock just as the shorts were trying to close out some of their trades. This caused a major rush to buy shares… and the more people bought, the harder it became for the shorts.
Clearing houses became concerned that trades would not properly settle and therefore placed margin requirements on the online brokers, who struggled to meet them. Robinhood did receive a cash infusion of $1 billion but still placed additional requirements on its own customers seeking to buy a variety of stocks including Gamestop and AMC.
The issue has created a firestorm in Washington, D.C. with politicians on both sides of the aisle accusing institutions of rigging the system against small investors.
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