(KERO) — It’s created a ton of talk online, and it’s something that money experts say they’ve never seen before -- a large group of inexperienced investors who discussed their plans on social media platform Reddit has shaken up the stock market in a big way. 23ABC’s Austin Westfall has the details on how they did it, and what local experts say about investing smartly during the pandemic in case you want to join in on the action.
Earlier this month GameStop stock was trading at $18 but jumped to $350 on Wednesday, and it’s because a group of strangers on Reddit banded together to give investment pros a run for their money.
“If there’s anything I like about the story, it’s that the little guy is finally pulling one over on the big guy," said Dave Anderson, financial advisor and co-owner of MoneyWise Wealth Management.
To understand what’s happening with the stock market right now, let’s start with the term "shorting." It’s how hedge funds and other professional traders profit from a company’s stock not rising but falling. A group of users on the website Reddit decided to use this to their advantage when they realized that some hedge funds were betting on GameStop stock falling.
Short selling is an investment or trading strategy that speculates on the decline in a stock or other securities price. It is an advanced strategy that should only be undertaken by experienced traders and investors. In short selling, a position is opened by borrowing shares of a stock or other asset that the investor believes will decrease in value by a set future date—the expiration date. The investor then sells these borrowed shares to buyers willing to pay the market price. Before the borrowed shares must be returned, the trader is betting that the price will continue to decline and they can purchase them at a lower cost. The risk of loss on a short sale is theoretically unlimited since the price of any asset can climb to infinity.
“So essentially what is happening is they're putting a lot of money into these companies," explained Anderson. "GameStop is an example of this. It’s driving the price of GameStop up. The short sellers, the hedge funds, are losing billions of dollars.”
Anderson said this is called "short squeezing," but he’s never seen a short squeeze this successful. The internet users in this situation ended up profiting. It worked for some people this time but is short squeezing a smart way to invest?
A short squeeze occurs when a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall, to buy it in order to forestall even greater losses. Their scramble to buy only adds to the upward pressure on the stock's price. Short-sellers borrow shares of an asset that they believe will drop in price in order to buy them after they fall. If they're right, they return the shares and pocket the difference between the price when they initiated the short and the actual sale price. If they're wrong, they're forced to buy at a higher price and pay the difference between the price they set and its sale price. Short sales have an expiration date, so when a stock unexpectedly rises in price, the short-sellers may have to act fast to limit their losses.
“It’s definitely not a safe method of investing. I mean anytime you’re seeing something going up 8,000 percent, and you’re hearing these stories of 'yeah I started with a thousand dollars and now I have a million dollars.' that tells you that it’s extremely risky,” answered Anderson.
Anderson said what goes up must come down, and GameStop stock is certainly higher than it otherwise would’ve been before the short squeeze. But some things have changed recently, with stock trading and investing app Robinhood restricting transactions toward several companies, including GameStop because of what they call “recent volatility.”
“If you’re just coming around now and hearing this news and going 'oh I'm gonna go in and buy GameStop because it’s going up.' you might be left with nothing.”
Anderson does have some tips for smart investing. He said you’ll be ok as long as you stay diversified in your investments and not put it all into a company like GameStop. And make time to let your investments mature.