In Jan. 2021, a group of amateur traders led from the subreddit WallStreetBets invested heavily into stocks of fledgling companies including that of Gamestop (GME) causing what is now being called the “Gamestop Short Squeeze”. To understand the investing craze and the Wall Street panic we need to start from the top.
In early 2021, Melvin Capital and other investment groups shorted the stock of Gamestop. Put simply, shorting is when a firm bets that the price of a certain stock will go down, and by doing so, gains profit even if the company is losing value. Users on r/WallStreetBets saw that many of these large firms were betting on the stock price going down, but they themselves felt Gamestop was undervalued. These groups of amateur investors then decided to invest into Gamestop through a number of different brokers such as Robinhood, skyrocketing the valuation of the company and thus the stock price.
Because investment groups had bet that the stock was going to go down and it was now going up, they were losing a ton of money. This was made worse by the fact that Melvin Capital had shorted more that 100% of the stock(in an attempt to get even more money out of the downturn). Because of these compounding losses, investment groups were forced to buy back the stock that they originally thought would fail, driving the price of Gamestop up even more.
Reddit traders had squeezed the investment groups out of their short position, thus a “short squeeze.” This immense increase in stock price did, however, come at a large risk, as Reddit investors were still susceptible to massive losses after the squeeze had disintegrated. Brokerage firms, such as Robinhood, then began to restrict users’ ability to purchase different stocks, due to their inability to post collateral when executing client’s orders.
Without getting into too much technical jargon, because of the immense volatility of the Gamestop stock, Robinhood needed to have some sort of collateral capital to offset the massive potential losses posed if the stock tanked again. They did not have it, therefore they needed to stop trading in that specific stock.
After having their accounts restricted, many amateur investors filed class action lawsuits against brokerage firms, accusing them of market manipulation. The SEC is pending an investigation and the US House Committee on Financial Services is holding a hearing on the matter on February 18.
In the grand scheme of financial markets, money manipulation, lawsuits, etc. this means absolutely nothing. Nothing Robinhood or any other brokerage firm did was illegal. In their terms of service Robinhood reserves the right to do pretty much whatever it wants with it’s clients stocks so most of these class action lawsuits will be dead on arrival.
Investigations into the actions of r/WallStreetBets will most likely produce no significant results as there is simply not enough evidence to prove that any sort of securities fraud occurred. The only impact this episode may have is producing increased youth involvement and interest in finance and stock markets.