First, we need to establish what shorting is, as it is integral to the story. Shorting a stock is essentially betting that a stock is going to decrease in price. But it isn’t that simple – in order for this to be done, an elaborate chain of events must happen. This involves the investor – who is shorting the stock and hoping the price will decrease – and the stockholder – who is willing to lend out his stock.

Firstly, the investor “borrows” the stockholder’s stock – they buy their stock from them, sell it off, then promise to give that stockholder their stock back at some point in the future. The hope is that between the investor selling the stock, and the investor buying the stock back in order to return it to the stockholder, the price will decrease, hence earning the investor a profit. Say the investor borrows the stock when it is at £100, sells it, then buys it back a month alter when it is £70, he will make a £30 profit from “shorting” the stock.

Now why would a stockholder agree to let the investor do this? The stockholder charges the investor a premium to short the stock – an interest rate is charged, so the longer the investor spends waiting to buy the stock back the more that the stockholder earns in interest. Of course, the stockholder is hoping that the price won’t actually decrease at all, as if this happens they will come out the exchange having made a profit.

So what does this have to do with Gamestop? Well, large hedge funds, like Melvin Capital, took a huge short position on Gamestop. A hedge-fund is a pooled investment fund – many individual savers give their money to these funds, who then invest it as they see fit and then give the returns to the savers whilst taking a cut for themselves.

But why Gamestop? This is due to multiple reasons – a good argument can be made for predicting Gamestop’s stock to decrease. Gamestop is like the US counterpart to GAME in the UK – it specialises in selling physical video game discs. Yet this market is clearly dying and seems to be doomed – online marketplaces for games, like Steam or the Xbox Games Store, beat physical disc stores both in convenience and in overhead costs. Moreover, some argue that the hedge funds were engaging in market manipulation by all piling in against Gamestop – more on that later.

Gamestop is the most shorted company in existence; 130% of Gamestops stock was shorted. Indeed, for every stock of Gamestop in existence, hedge funds had promised to return 1.3 to stockholders. How this is possible is very complicated, and may even be illegal, but the idea is that if the stock price falls enough stockholders will not exercise the option to return the stock, and hence the hedge funds can get away with never actually buying back the stock.

On an internet forum called Reddit, users noticed the huge short position in place against Gamestop and began talking about the possibility of a “short squeeze”. Now what is a short squeeze? The idea is that at some point, the shorters who sold the shares (betting the price was going down) have to buy them back again at some point to return the stocks to the stockholders. If, for some reason, the price suddenly increases rapidly, the shorters will be facing huge losses and will want to close their positions to prevent further losses. Therefore, they will buy up shares to close their positions. These purchases will further increase the price, hence creating a self perpetuating cycle.

When the company was shorted as much as it was, this price increase can be huge, earning stockholders huge profits, and, more importantly in the eyes of some, losing huge amounts for the hedgefunds. Moreover, some had the idea that if enough of them bought the stock, they could collude together to demand huge amounts from the hedgefunds to give them the stock back. Since the hedgefunds are legally obligated to buy over 100% of the GameStop stocks in existence, if every stockholder colluded they could theoretically demand huge sums of money for the stock, hence pushing up the price further.

Realising a short squeeze was possible if they colluded to buy up Gamestop stock to increase the price, Redditors started buying up Gamestop stock, instigating the short squeeze. And it was successful. At its height, on January 28th, the short squeeze increased the stock price from $500 per share from the $17.25 it started at at the beginning of the month. By the same date, Melvin Capital had lost 30% of its value since the start of 2021. Losses on short positions in US firms topped $70 billion. Some individual investors became incredibly wealthy. 34 –year-old Gill, who had the username “DeepF******Value” on Reddit, say a $53,000 investment made in Gamestop in 2019 grow to become valued at $48 million by January 27th.

Yet such success seems shortlived. On January 28th, multiple brokerages, including the very popular Robinhood, prevented users from buying Gamestop stock. Such a decision seems like clear market manipulation – if investors are prevented from buying stock, yet are still allowed to sell it, it is only natural that the price will decrease, and thus the brokerages are interfering with the free market. Moreover, 35% of Robinhoods revenues comes from Melvin Capital, adding even more suspicion that Robinhood was just acting to protect its owners. This being said, plausible, legal explanations can be made. Robinhood claimed that the restrictions were the result of clearing houses (where the brokerages go to get the stocks to the buyers) raising the required collateral for executing trades (What does collateral mean? If you take out some sort of debt, like a loan, you can put forward an asset you own as “collateral”, so that if you cannot pay off the debt for some reason the creditor will seize your asset and sell it off). Multiple lawsuits have already been taken against brokerages like Robinhood, accusing them of market manipulation. Regardless of the legality of these actions, they were successful in reducing the price of the stock. On February 1st and 2nd, the stock price was a mere 20% of its peak recorded during the previous week, losing 80% of its value.