In 2021, stock shorting sparked a war on Wall Street between Reddit forum retailers and hedge funds . The reason? Retailers on Reddit boosted shares of companies that were sinking and were speculated by investment funds to go down. Using this short-selling strategy, GameStop shares rose more than 1,500% in just two weeks.
In this post we are going to learn more about what short selling is and how it works, with the aim of better understanding the case of Reddit forum members and how they are now beginning to restrict this kind of operation. Here we go!
What is short selling?
Short selling stocks in Nigeria is basically making a negative trade in an asset. That is, sell high and buy low to profit from the change in the price of the asset.
The trader anticipates a decline in the market and begins to make short trades to benefit from this decline.
If in the stock market you make money when the shares rise, in the short sale of shares the operation is the other way around, you make money when the shares fall.
How does short selling work?
How does the investor carry out this operation? It simply sells the stock on the market for its current price, then its value falls, and the trader buys it back for a lower price.
In this way, the trader pockets the price difference between the value for which he had sold the shares and the value for which he bought them later.
The greater the difference between the initial sale price and the subsequent purchase price, the more profit the trader will make from short selling the stock .
What times are best to short sell?
Selling short in the Nigerian stock market has a large part to do with speculation and forecasting future declines. Therefore, the moments in which this type of sale and purchase operations are usually successful are:
- When a financial crisis occurs, the uncertainty will cause prices to fall.
- When there is a scandal within a company, it will almost certainly lead to a stock market crash soon after.
- When a company files its earnings report at a loss, before long these losses will also show up in the drop in its stock.
In the case we are analyzing, the investment funds were taking advantage of the company’s bad situation to bet on the shares short.
What happened to GameStop stock?
In the case of GameStop stock, given the poor financial situation of the company in mid-January, investment funds were speculating on its bankruptcy. With this premise, they began to invest in short shares to profit from their subsequent purchase after the stock market crash.
But at the time, users of the Wall Street Bets forum on Reddit organized to boycott this strategy. These retail investors prompted the massive purchase of GameStop stock, so that, contrary to investment fund predictions, the stock began to appreciate in value. Mutual funds began to lose money shorting their shares and many had to close their positions to avoid further losses.
This same strategy was also replicated by retail investors with other companies such as Nokia, BlackBerry, Bed Bath & Beyond or Express, with the same result.
Why do trading platforms restrict short selling?
Certain stocks may be prevented from being short-sold by certain regulators in order to protect companies from speculators.
To counteract the boom in the growth of GameStop and other stocks, several stockbrokers have placed restrictions on trading in these stocks.
On the other hand, the legality of the organized purchase of shares is being analyzed , since it is a way of manipulating the price of a financial asset.
In conclusion, measures and restrictions are being put in place to limit speculation and protect companies and investors from large losses from short selling or organized stock buying.