- Hey, welcome back,
it's Nolan Matthias,
and in today's Five Minute Friday,
we're gonna discuss the basis of short squeezes.
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Okay, so let's get into it.
Let's discuss short squeezes and what they are
because they have been the primary topic
in the news cycle this week
with what's going on with GameStop,
AMC, Blackberry and a bunch of other different companies
that are being squeezed
by a group of Redditors called wallstreetbets.
And in order to understand how a short squeeze works,
we first need to understand how short selling works,
and this is a really simple explanation
of how short selling works.
Basically, when you're short selling a stock,
you are borrowing a group of stocks from your brokerage
and you are selling it into the open market.
And what your hope is
is that the value of the stock is going to go down
so that when you buy it back
and give it back to the brokerage that you borrowed it from
that you are going to earn a profit
because what you sold it for
less what you bought it back for ends up being your profit.
And that's how short sellers make money.
But the problem with short selling
is that if you are in a situation
where the value of the stock goes up instead of down,
well, you start to incur losses.
And unlike a long position
where you're buying a stock and holding onto it,
if you've short sold a stock,
your losses are potentially infinite
because in a long position,
your risk is the amount of money that you invested.
So let's say you're buying a stock to hold it
and the value goes to zero,
well, your potential losses are what you invested.
But in a short position,
your potential losses are infinite.
So for an example,
if you were to short sell a stock for $10
and instead of going down in value,
that stock went up.
And let's say it went up to $20,
well, you've now lost $10.
But if it goes up to $100,
you've now lost $90,
and so on and so forth
until such time as that stock basically maxes out in value.
And that's what's brought us to today
and the conversation with respect to short squeezes,
because what has happened is that,
in the case of GameStop,
there has been a recognition
that short sellers have borrowed more stocks to sell
than what actually exist in the market.
And what that means
is that it becomes very hard for the short sellers
to cover their position and limit their losses.
So this group of Redditors, wallstreetbets,
figured this out
and is basically putting upward pressure on the stock
by buying call options
and buying the stock itself in order to push the value.
And the higher that the wallstreetbetters
push the value of the stock,
the more that the short sellers
have to lock in their losses.
And in order to lock in their losses and cover their losses,
they have to buy back the stocks.
And as they buy back the stocks,
well, guess what?
That adds more upward pressure,
which means the value of the stock goes up and up and up
and then more shorters have to cover and cover
and cover and cover.
And it basically becomes this infinite loop
of short sellers having to cover their losses
as the stock goes higher,
which continues to push the stock
higher and higher and higher.
And eventually what ends up happening
is the short sellers have to either completely give up
or they go bankrupt.
And this isn't something that's new to the market,
GameStop isn't the first company to get short squeezed.
It happened to Volkswagen back in 2008,
and it's very much something
that investors and institutional investors do
when they see
that there's large short positions on a company
and that there's an opportunity
to push those short positions
into a position where they have to cover
and therefore push the value of the price higher
and higher and higher.
Now, this last week
is the first time that a group of retail investors
or basically amateur investors
have been able to short squeeze
a major institutional investor or a hedge fund,
but that's exactly what happened.
And for whatever reason,
all the stars aligned into this perfect scenario
where a group of Redditors
were able to recognize that there was this opportunity
and continue to push the stock,
and in this case,
GameStop or AMC or Blackberry,
higher, higher and higher to make these hedge funds
and institutional investors cover their short bets
on these companies.
So this is really a once in a lifetime situation
where you see retail investors taking on the giants.
It's very much a David and Goliath story.
The short squeeze itself
is not something that is new
or something that is unknown to the market,
but definitely the circumstances over the last week
and how this has played out is new to the market
because never before has a group of retail investors
been able to manipulate the market
in such a way that big hedge funds
and big institutional investors have to take their losses.
And really a cool scenario
where we're seeing hedge funds have to take their medicine
where normally it's the retail investor
who gets screwed in a lot of these situations
as opposed to the big institutional investors.
So that's it,
that's how short squeezes work.
That's today's Five Minute Friday.
Hope you enjoyed it,
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