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The Truth About the GameStop Short Squeeze

Each of the three major indexes dropped by the most since October on Wednesday amid a batch of tepid earnings results, but GameStop is the big story on Wall Street this week.

GameStop is a failing company with no fundamental reason to see its stock doubling every day. The stock is up more than 1,822% intraday since Jan. 4. It was trading at $341 at midday yesterday. Dozens of circuit breaker halts were triggered in early trading on Wednesday as volatility hit several stocks including GameStop, AMC Entertainment, Bed Bath & Beyond, Nokia and Koss. Trading halts give traders time to digest news and adjust their trades over, but have done little to help smooth out trading of these stocks. Several online brokerages like Robinhood, Charles Schwab, E*Trade, and TD Ameritrade saw extended service disruptions, as their systems are not equipped to handle this sort of trading activity. What Happened with the GameStop Trade Hedge funds see a short opportunity in a company that's in some trouble and they go short. In this case traders on the Reddit WallStreet Bets saw the short trading and started trading the stock. It’s unusual to see retail investors mostly on the Robinhood platform, squeezing short trade like GameStop. But this short squeeze happens to be thousands of traders loosely coordinating on Reddit. This is new, but the basic mechanics of opposing forces behind a short squeeze like this is not as novel as it seems. Just realize this strategy is not sustainable. The stock will correct to something closer to true value as these traders start taking profits and the bubble pops. Here's a chart of GameStop trading compared to TSLA. It highlights the extreme run-up on the stock as well as the crash last week. As of Feb. first the stock is down 25% in morning trading.

You can expect regulators to step in and investigate. The SEC and the Treasury department will look into this sort of trading activity. The Reddit traders should prepare for stricter rules and regulation shortly, which will kill the idea that what happened with GameStop will happen with others. Several brokerages restricted trading in GameStop and Nasdaq could halt trading activity for a stock targeted by Internet users, which would enable investigations into manipulation. Robinhood and other platforms like it could be subject to new rules. More news coverage

Robinhood says restrictions on GameStop due to tenfold increase in clearinghouse deposit requirements

Read in CNBC

GameStop stock short seller losses total more than $19B, data firm says

Millions of GameStop shares are still shorted

Read in Fox News:

How Reddit made AMC, GameStop stock go wild: An 'insane''Ponzi scheme'

Read in CNet.

Overall the outlook for stocks still appears to be positive. At the Federal Reserve, Chairman Jay Powell made it clear the central bank was not exiting massive support for the economy, leaving benchmark interest rates near zero and repeating a pledge to maintain its bond-buying program at the current pace of $120B of purchases per month. Stock futures edged lower Thursday morning after the selloff on Wednesday.

Floyd Saunders is the author of Figuring Out Wall Street. His next book, Five Simple Paths to Wealth will be published in March. You can learn more about him at his author web site.


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