Explained: GameStop & How Reddit Caused Wall Street Billions In Losses

An unexpected army of Reddit users have driven a buying frenzy in stocks such as GameStop and AMC, leaving seasoned Wall Street hedge funds who bet against these struggling companies, to swallow billions in losses.

The ongoing surge in its stock price is the result of an extraordinary turn of events following the ordinary trajectory of business decision. GameStop - a video game and console retailer that sells both online and in stores - announced plans to shutter 1,000 of its store by the end of March 2021, due to the fallout of the COVID-19 pandemic. All of this while previously suffering losses and being mired in debt, though they expect strong fourth quarter sales (1st quarter of 2021) and have seen good growth in their online sales of games during the pandemic.

With these developments in mind, hedge funds, investment firms and Wall Street decided to "short sell" the shares - to take a position that the stock will fall and buy it later at cheaper prices, thus making a profit in the process. But, an army of retail traders have banded together to buy the stock at astronomical rates and push it higher and higher, causing the market short position takers to incur heavy losses.

More implicitly, GameStop has become the venue of an investment jostle between two classes of investors, a David of small buyers versus a Goliath Wall Street rumble, forming the crux of the story.

At the start of the year, on January 4, you could pick up GameStop's shares at $17.25 apiece, shows data from Yahoo Finance. Starting January 22, however, it's galloped away, starting from $42.59 to $347.51 as of the end of trade on January 27, hitting an intraday high of $380 on the same day. From January 26 alone, GameStop gave returns worth 134.84%, rising from a close of $147.98. This phenomenon has spilled over into other shares that have seen similar short selling. AMC, a struggling movie theatre chain, for example, opened on January 19 at $2.8. But it has closed on January 27 at $19.90, in a 610% rally in just a week.

But, the price tag faced by the winners and losers during these turn of events has run into the billions. More than $6 billion has been lost by short-sellers year-to-date on GameStop, while its three largest promoters have gained more than $2 billion this year. AMC on the other hand, made $304 million on January 26, but could have made four times that amount if had only waited a day more. Citron's founder, Andrew Left, covered his short position at a 100% loss while Melvin Capital, known to outdo the markets, also said that they have covered their position at a loss, though they did not disclose a quantum. Billionaire Steven Cohen, whose firm Point72 manages $19 billion in assets, made a 15% loss covering his position on GameStop.

The weird side

What makes this entire saga peculiar are the quirky episodes within in. For starters, various retail traders have used Reddit - specifically subreddit community 'Wallstreetbets' - to egg this rally on. The page describes itself "like 4chan found a bloomberg terminal illness, and uses a synopsis of its purpose as:

/r/wallstreetbets is a community for making money and being amused while doing it. Or, realistically, a place to come and upvote memes when your portfolio is down.

Find it here.

The world's richest man, Elon Musk, also drove the stock price higher when he tweeted, "Gamestonk!", where 'stonk' is meme-lingo to refer to a stock. When he tweeted this - with the link to Wallstreetbets - Gamestop touched an intraday high of $150 from its opening of $88.56, or near 69% higher.

The rise of low-brokerage app in the US that has been used by small time traders - Robinhood - is also considered to be a part of this puzzle that fits all too perfectly, which has been used to the fuel the rally. Some users of social media joke that it has literally emerged as a platform that steals from the rich and gives to the poor.

Frenzy reaches US Government

The massive sprint in the share of the stock price has reached the gates of a week-old Joe Biden-led US Government.

The White House, and Janet Yellen are reportedly keeping their eyes on this rally. "Our economic team, including Secretary Yellen and others, are monitoring the situation. It's a good reminder, though, that the stock market isn't the only measure of the health of our economy," Jen Psaki, the White House Press Secretary, said in a press briefing.

The Securities and Exchange Commission - the market regulator in the US - has also said on January 27 that it is monitoring the ongoing volatility. Such rises, without justifiable underlying business activity could draw the attention of regulators.

After market, GameStop is trading 9.36% lower, and AMC 24.02% lower.