Photo of Eric R. Ebbert, CFP®, MBA, CEO Eric R. Ebbert, CFP®, MBA, CEO Jan 23, 2021

If you have spent any time online recently, you have probably heard something about Reddit r/wallstreetbets. Somehow, at the time of this writing, GameStop’s stock has soared in a remarkably short period of time. Meanwhile, hedge fund investors have lost roughly $5 billion. 

So, what exactly is going on? Turns out, some short sellers lost at their own game. Big-time.

Breaking down the “Reddit r/wallstreetbets” incident

If you are unfamiliar with trading stocks, this might be a little tricky to follow, but we will do our best to make it clear for you. Essentially, what happened is some individual investors and short sellers bet that GameStop’s stocks would plummet, and they made a move to make money off it. 

The way this works is by short selling. This is the practice of borrowing shares for a fee and selling them for (ideally) a high price. Then, they hope to buy the shares back at (ideally) a low price to return them to the lender. This practice can make short sellers a lot of money in a little time, especially if the company they are betting on declares bankruptcy and they do not have to return the shares.

This is exactly what some investors and hedge funds aimed to do with GameStop. They saw it as a failing company and placed their bets on it by short selling. Unfortunately for them, day traders on Reddit’s r/wallstreetbets’ subreddit had other plans.

When they found out about the short sellers’ intentions, Redditors made several posts as a rally call to buy shares in GameStop, causing the value of the shares to skyrocket. And because short sellers were holding the shares, they were forced to cover, or buy back the stock at a higher price, which causes the value of the shares to increase even further.

In other words, the value of GameStop’s shares increased, the short sellers had to cover for this increase, and they now have shares that they cannot sell back at a higher price than what they paid for them with their borrower’s fees.

What can investors learn from the Reddit r/wallstreetbets incident?

One important lesson to gain from this incident is that short selling is incredibly risky. Yes, many investors practice short selling on a regular basis and generate profits, but they expose themselves to exactly this kind of incident that ends up costing them a fortune.

Another lesson to learn is that the market moves much quicker than you might expect. The day traders on r/wallstreetbets learned about the short sales and were able to rally several people in a short period of time to shatter the short sellers’ plans, which brings us to the third lesson.

People on the internet need to be taken seriously. While this might not be the case across the board, it seems that the motive of the day traders on Reddit was to punish short traders for manipulating the market. The short sellers never anticipated the day traders could actually pull off this stunt, but they did, and now the short sellers are paying for it.

Talk to a ProVise CFP® professional about your investing strategy

People who short sell for a living play a dangerous game, but this is not how investing works for the average investor. For many people, investing takes place in the form of a retirement account or by building a portfolio to reach some long-term goals. Still, even these forms of investing come with some risks, so it is always a good idea to work with a professional financial advisor for guidance.

At ProVise Management Group, our CERTIFIED FINANCIAL PLANNER™ professionals can get to know you and your current financial circumstances, goals, risk tolerance and personal values to help you develop a plan that works for you. We can also create a written plan for you at a fiduciary standard of care. All our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.

Are you ready to talk to a professional about your investing strategy? Contact ProVise today to schedule a complimentary consultation.