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The GameStop Frenzy: A Breakdown

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This week marks an unprecedented moment in market history, and an odd one at that. A host of small time retail investors–congregating under the forum r/wallstreetbets of the popular content sharing site Reddit–have upset the market in spectacular fashion. With tinges of humor and anti-institutionalist sentiment, the group chose GameStop stock (GME) as their rallying point. From there, they struck gold, expanding to other struggling businesses in a string of investments that sent the market into chaos. 

How did this all happen? To understand it all, it’s best to start with the struggling video game retailer itself. GameStop, many had argued, was on the way out, to be replaced by online and video game platform purchasing as well as large retailers like Walmart and Target. [1] Its stock was falling. More importantly, a host of hedge funds had aggressively shorted GME, expecting its collapse. [2] Shorting is a complex trading strategy that involves borrowing a stock, selling it at a price you believe to be overinflated, waiting for the stock to fall to the expected value, buying back the stock at the lower price, returning borrowed shares, and pocketing the difference. Put simply, it is a bet that a stock will fall. 

Recognizing this position of major hedge funds like Melvin (which was nearly bankrupted by what happened next), a so-called army of Reddit-based retail investors began purchasing GME at stunning rates. Within the course of two weeks, GME rose from lows of $2.80 a share to a peak of $492 a share; though, it is currently wavering around the mid-300s. The volatility was a shock to many financial institutions and has drawn significant public attention.

The popular no-fee investment app, Robinhood, was so burdened by the sudden burst in trading volume that it temporarily banned users from purchasing GME and other “meme” stocks targeted by r/wallstreetbets. Though it has since reopened trading on these stocks, Robinhood drew strong bipartisan disdain for the move which some saw as protecting imperiled hedge funds. [3] Robinhood claims that the move was necessary to ensure a continued ability to make market clearinghouses deposits amid the unprecedented trading volume. [4] In other words, they needed to ensure they had enough cash on hand to meet their surging financial requirements, a claim supported by the $1 billion Robinhood raised this week through emergency fundraising. [5]

In this respect, Robinhood is not alone. Other brokerages like Charles Schwab also temporarily paused trading and have acknowledged that the frenzy has significantly burdened their systems. As for the host of newfound GME investors, they are ‘continuing to hold.’ [6]

All of this has drawn weary and excited eyes from all market players. While some have sought to label the Reddit army’s collective effort market manipulation, others have sought to label the ban on trading similarly. As a result, all eyes are on the SEC, who will hopefully clarify what has happened and what will come of this unprecedented, volatile market activity. For now, they have left us with this warning: 

“We will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws. Market participants should be careful to avoid such activity.” [7]

Sources:

[1] – Schneider, Avie, “Game Back On: GameStop Stock Rebounds As SEC Warns Against Market Manipulation,” NPR, 29 Jan. 2021, https://www.npr.org/2021/01/29/962047287/game-back-on-gamestop-stock-rebounds-as-sec-warns-against-market-manipulation, accessed 29 Jan. 2021.

[2] – Ibid.

[3] – Ibid.

[4] – Fitzgerald, Maggie, “Robinhood restricts trading in GameStop, other names involved in frenzy,” CNBC, 28 Jan. 2021, https://www.cnbc.com/2021/01/28/robinhood-interactive-brokers-restrict-trading-in-gamestop-s.html, accessed 29 Jan. 2021.

[5] – Op. Cit. n1.

[6] – Ibid.

[7] – Ibid.

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