The GameStop Saga in 3 minutes

NYSE listed GameStop owns a chain of US-based video game stores and is the parent company of the Australian chain, EB Games. Like many brick-and-mortar retailers, COVID-19 has had a dramatic impact on operations, particularly given the current generation of gaming consoles allows consumers to download games at home, instead of purchasing a physical disc or cartridge.

This hasn’t stopped GameStop shares from surging. In April 2020 they fell as low as $2.53, and by the end of the year, they were trading at $18. In the last month, the shares have exploded, reaching a peak of US$483 following the intervention of a community of online share traders – organised via the Reddit forum r/wallstreetbets.

The actions have been seen as a righteous stand against the Wall Street establishment and short-selling US hedge funds. Short selling, the common albeit controversial, strategy where investors bet on a company’s share price falling. The practice has a checkered history, with many market participants seeing them as necessary to help expose fraudulent company behaviour and also provide liquidity. However, some short-sellers have been accused of manipulating markets with unjustified and false claims that ultimately shock stock prices lower regardless of their validity.

In the case of GameStop, US hedge funds Melvin Capital and Citron Research known for their short positions in the company, were betting on it continuing to struggle during a tough time for physical retailers.

The collective online effort of the wallstreetbets Redditors pushed GameStop’s share price exponentially higher, creating a huge “short squeeze”. Which forces short sellers to close out positions at the same time, causing a huge spike in the share price, in a bid to avoid theoretically infinite losses. Caught unawares Melvin Capital and Citron Research both closed their short positions, buying the shares back at a much higher price than they sold them, suffering huge losses.

The event has been facilitated by relatively new trading platform Robinhood, one of the first firms to offer commission-free trading. The app has boomed with a generation of millennials caught at home in the COVID crisis. The platform also provides a huge social interaction component to trading.

The controversy hasn’t ended with the hedge fund licking their wounds. Robinhood itself has sparked fury with both customers and US politicians after it told its users that “in light of recent volatility”, it was restricting trading on stocks including GameStop, Blackberry, AMC Entertainment and Nokia so that users could only sell these stocks, and not buy them. The move raising questions as to whether Robinhood is acting in its own interests by restricting trades.

Congresswoman Alexandria Ocasio-Cortez tweeted - “This is unacceptable. We now need to know more about RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit. As a member of the Financial Services Cmte, I’d support a hearing if necessary.”

Opinions appear to be divided, many are cheering on the Reddit traders, encouraging everyday investors to make their voices heard by finding a new way to play in a complicated system that has often given advantages to professional investors. While many are quick to highlight the risk of following online rushes in the hype. Unless investors believe traders will push prices higher indefinitely, many will be left hurting if caught unawares when/if things go south. Precisely what happened to Melvin Capital and Citron Research.