How the GameStop game will stop
28 January 2021
Having spent some time perusing the crowd psychology at work in the so-called "short squeeze" of GameStop Corp (GME), their almost religious beliefs expressed in the echo chamber of the WallStreetBets Reddit page seem to run broadly as follows:
- We know the stock is trading at many times its fair value, but we don't care because...
- we are "hurting" big hedge funds which short stocks they think are overvalued and...
- we're the little guys, so we are making money at the expense of the obscenely wealthy cabal that run hedge funds, the 0.1%, whom we blame for [insert socio-economic woes of your choice]. This is a "movement", a "financial revolution" and "we're gonna hit them where it hurts".
What most of the foot-soldiers in the Reddit Army don't seem to realise is that apart from transferring wealth to their superiors, with late entrants enriching early entrants as they exit the bubble, the new recruits are eventually going to enrich the final cohort of short-position holders when the bubble bursts.
The sum of all long positions minus all short positions is always 100%. For example, if the outstanding short positions are (as reported/estimated) 140%, then the long positions are 240%. A share can be lent and borrowed an unlimited number of times, each time expanding the long and short positions by 1 share when it is sold - it doesn't have "I am borrowed" written upon it. Even if some shares are withdrawn from the lending pool in circulation, the others can be relent. So buying stock isn't necessarily going to move the price as long as someone else is equally willing to sell it or short it. Theoretically then, a stock can be 1000% long and 900% short.
Yes, some short-sellers may have closed their positions, unable to withstand further losses, but others will always be willing to step in against an increasing price. Similarly, some early buyers have already taken their profits and quietly walked way. So how will the GameStop game stop, or end? Probably the same way most bubbles do. This is a zero-sum game, unless the company issues new stock. The further a stock price deviates from sensible values, the greater the temptation to sell, whether you are long or going short. Think of it as a helium balloon rising up through the atmosphere - it expands and eventually bursts, dropping its payload.
Those with the largest gains will quietly cash in first, particularly if it represents a life-changing, massively-overweight position for them, absorbing the last foolish money to buy in, and as the momentum reverses, the whole thing will rapidly crash. So, we have news for the Reddit Army: you're not necessarily hurting short-sellers as a group. The final short-holders, if any, will win their bets. The only thing for sure is that you are enriching the early leaders of your army, some of the loudest people on your site, at the expense of everyone else, long or short. "HODL" is their rallying cry - but the pilots will bail out. "This is your captain speaking: on behalf of the entire crew, we apologise for interrupting your flight, but for those of you sitting on the left-hand side of the gondola, if you squint, you can see us in the yacht far below. Thank you for choosing Stratospheric Airways."
In case you're wondering: Webb-site has never traded GME, long or short.
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