How Robinhood stole Gamestop’s stonks: Understanding what happened to Gamestop shares.
The story of Gamestop shares getting high took over social media as it wasn’t apparent that a dying company with a dying business model can suddenly have such a high surge in stock value. Apparently, a group on Reddit called Wallstreet bets was behind it through using the investment application called “Robinhood”. Since the story can get a bit confusing with many technicalities in it, this article is made to explain what really happened in simple terms for everyone to understand this revolutionary way of distributing wealth.
Who are the companies stuck in the middle of the hype?
The Texas-based company started way back in 1984 when it was called Babbage. It started off by focusing on software sales until it shifted into gaming gradually. It started to appear all over the States when it was selling Nintendo games in 1987 and then eventually shifted completely to gaming in 2000 and changing its name to the currently known “Gamestop”. At the time, the business model was functional as most people had to go to shops in order to buy video games and video game consoles. At the time, it was the blockbuster of video games and the company reached great heights as the shop was present in almost every shopping mall in the western world eventually becoming the world’s largest video game retailer in its height, operating 5,509 retail stores throughout the United States, Canada, Australia, New Zealand, and Europe. However, with the move towards digitalization of video games the company faced a decrease in stock values and company performance in 2019. The company lost 795 million dollars due to the COVID-19 outbreak and in 2020 lost millions. All of this led the stocks value to fall all the way down to 18$, until the recent stock exchange war made it reach an all time high of 325$.
Inspired by the financial crisis back in 2013 Robinhood was established in New York by two Stanford graduates Vladimir Tenev and Baiju Bhatt who already built high-frequency trading platforms for financial institutions. Their expertise in the market allowed them to build an app that would “provide everyone with access to the financial markets, not just the wealthy”.This became their mission statement as they wanted to democratize finance for all and allow anyone to invest at their own pace. This created a commission-free investment environment and allowed beginners to learn finance and trade in a simplified manner.
Melvin Capital Management LP is an American investment management firm founded in 2014 by Gabriel Plotkin and based in New York. The company’s hedge funds focus on tech and consumer stocks and are reported to have billions worth of assets. The company’s name rose recently as it became one of the large hedge funds short-selling Gamestop stocks and ended up facing large losses due to the recent short squeeze.
r/Wallstreetbets VS. Multi-billion Hedgefunds
The story started with a post on the r/WallStreetBets Reddit community, a community composed of amateur traders. They are mostly young people starting off in trading and relying on online trading. The post was about the biggest short squeeze of your entire life! In simple terms, it was the perfect time to attack large hedge funds by buying stocks altogether while catching the hedge funds in the middle of their dirty act of short selling. This led to a short squeeze, which will cause huge losses for hedge funds while gaining some profit from the act of boosting up the prices of the stock.
What is a hedge fund?
Hedge funds are large investment funds created by accredited investors and most often set up as private investments with limited partnerships that require a large minimum initial investment. Such investments follow multiple strategies through pooled funds which eventually lead to earning active returns, or alpha, for their investors.
What about the terms? I keep hearing them but can’t understand them.
in the following section, there will be a simple explanation for all these terms in order to see how the true redistribution of wealth should happen.
Margin (A basic form of investment): When you hear margin, have this in mind (Margin=debt). Margin is money you borrow from a brokerage firm to buy some stocks after telling them what you are intending to get. For instance, Ben wants to buy 100K worth of stocks on Amazon. The firm meets my 100K after Ben makes a profit during the agreed period of time Ben returns the 100K along with the commission and service fees. Many investors get into this in order to get into investments and the losses would be directly related to what they bought.
Short Selling (Hedge funds dirty work): Let’s talk about short selling, a method which hedge funds have been using for years and profiting from a lot. What is the controversy around it? Maria wants to profit from a company’s recession so she evaluated that she can short sell their stocks, so she goes to a broker and they form an agreement she borrows the stocks for a period of time (a month) after a month, Maria will return the stock plus a commission 10$. In this case. The price of stock is now 50$ in the market. Maria sells it and now has 50$ in her pocket. After a month, the stock price decreased in price to 20$. She buys it back and gives it back to the broker plus the 10$ netting 20$ in profit from this transaction only.
Short selling is a risky business because it can lead to unlimited losses and to scenarios like the short squeeze.
Short Squeezing (Power to the people):
This is when a jump in the price of stocks would eventually force short sellers to want to close their positions, which in effect causes the price to go higher. To explain further.
A new car is entering the market, however, the car shows a few technical gaps. Some investors notice that and want to profit from its depreciation through short selling. The stock now costs 50$, and investors buy it accordingly, hoping the value will go down. However, the car performs well and many people rush to buy more stocks, driving the price up to 200$. The short-sellers have a month to return the stock. As it passes, they lose in their investment and have to pay 150$ in losses to return the stocks to the brokers. What is worse is that it adds more supply that doesn’t exist that will eventually boost losses.
In the case of GameStop, the rise in the value of shares wasn’t because the company performed outstandingly well, but it was because of a coordinated bullish movement in which amateur investors decided to stop hedge funds from profiting from shorting businesses.
Robinhood halts all the GME stock purchases: you have failed us.
Many in the community of Wallstreetbets have been using apps such as Robinhood in order to invest. The app is commission-free and easy to use for everyone especially for young people who want to enter the world of investing in an easy way. However, what happened recently with the halt on GME stock purchasing from Robinhood shows another side of the story and how Robinhood fails in their moral standards this time in the world of stocks.
Users speak up against the limitations set by Robinhood and other brokerage apps on stocks such as Nokia, AMC, and others which were being “overbought”. There is a big push for a class-action lawsuit against Robinhood as there are claims that the company is slowing growth in order to benefit its institutional investors and partners. Robinhood’s response was that this was made to meet SEC’s net capital obligations and clearinghouse deposits. They said they didn’t do it for the benefit of a player in the market. Some claim that Citadel is behind this push for regulations on the side of Robinhood as it is the company that clears trades for Robin hood. This company had lent Melvin Capital 2.8 billion dollars which was on the brink of bankruptcy because of their Gamestop shorts. The same scenario is probably present in all brokerages, whether it is out in the open or behind the scenes. However, we can’t be sure that this is the sole reason behind it. Webull and Robinhood shared their responses on the situation to the media but it is up to you to judge who explains it better as we should remain objective on the matter.
Assessing the damages: An interview with the Lebanese/Bulgarian trader Paul Nawfal
In order to get a clearer idea on the topic, I consulted someone with experience in observing stocks on a daily basis and check an expert’s point of view on the matter. I contacted Paul who has been observing the market in the midst of all this madness as it is part of his job as a trader. Here are some of the questions we discussed.
1-What’s the deal with short squeezes, are they common in the trading world?
Short squeezes aren’t that common. While they do exist.a lot of them go silently under the radar with firms profiting from them. For the moment there have been a couple of larger cases that caught the attention of the media. One of the largest ones occured when Porsche was in the process of acquiring Volkswagen. Near the end of the acquisition,there were 6% floating shares and double the amount of stocks being shorted at 12% which led to around 20billion $ in losses for hedge funds. Tesla also faced several short squeezes which ended in 10–15 billion $ losses to investors who deemed the stocks to be overvalued. They thought the value was going to depreciate and many started short selling, however it backfired and they all faced major losses.
2-What is the outcome of the whole r/wsb vs hedge fund scenario? What were the damages caused to hedge funds? Will wsb traders face any losses in the long run?
Two of the biggest investment firms that invested in shorting GameStop borrowed at 20$ and wanted to sell at 10$ to post 100% profits. However, the stock prices started skyrocketing as r/wsb users started buying options and buying up the stocks. This caused very large losses for the hedge funds shorting the stock. Melvin capital lost around 2–3 billion and had to borrow from friends to cover their positions, while others had to close positive gains on positive positions in order to compensate for their losses. As for Wallstreetbets, for now, they are safe as long as they are holding stocks as all shorters have to buy the stock in order to close their short positions. This causes the prices to keep going up as they are holding them hostage, through holding. The short-sellers should pay more and more in order to buy stock to be able to close their positions. This can go in two ways: the wallstreetbets guys give it up and sell shares to cash in profits or keep holding up until the other firms go bankrupt and the price eventually stabilizes.
3-Why did Robinhood halt GME stock purchases in your opinion?
The Robinhood scenario is kind of funny. They are a brokerage firm with many investors so obviously what comes to mind when they halt trading is that they are helping out their big investors to minimize their losses. That isn’t necessarily the scenario. Despite there being a potential for a conflict of interests, with one of their biggest investors being Citadel Holdings(involved in a 3% GME short). Citadel had to cash in some gains from silver to cover their losses in GME. The situation became a bit complicated for Robinhood, as they have to remain FTC compliant. In order to do that, every time there is a transaction, the company should cover both the buy and sell-side and they have to have enough capital at hand for both. It turned into a difficult situation to sustain as the price soared to 300–400$. . It is important to remember that Robinhood don’t take commissions on trades, but they earn fractions of cents by routing their orders to High Frequency Trading Firms.. They have a lot of trading and investors on the app. For instance 3 million people on reddit and assuming that each holds a position of 100$ 100x3million is $300 million. So you can imagine what happens if the numbers keep moving up. This is a conservative figure as some invest in the $1000s and $10,000s. Overall, Robinhood wasn’t able to provide the capital in order to cover the deposits as a brokerage firm. They are liable for everything and have to cover for both sides(the buying and the selling) but eventually they reached a situation where they had to halt the trading or they would face the risk of having to liquidate their capital, it was basically a capital problem which also other firms such as trading 212 in europe had to resort to halting trading in order to keep up.
4- can we expect more attacks to come? What do you think are wsb traders' next targets? Nokia, DOGE, Blackberry
We can expect more attacks in the future however they will be nothing of the same magnitude as l the case of Gamestop. GameStop shorts reached unprecedented values of 120% of the shares being shorted and having to be bought back by these large firms and investment funds/. The biggest short squeeze before this case was Volkswagen when it had a 12% short on shares with 6% floating rates. As for GameStop 50% are owned by stakeholders, floating is about 40%, and the shorting is 120%. It was a huge mistake by the hedge funds for over shorting the stock. After this scenario, there wouldn’t be a similar case as they will definitely be more careful as to not allow a similar scenario from arising. Small groups of coordinated investors acting as one large group (Miniature hedge funds) can cause price movements such as the case of Nokia.AMC, Dogecoin, and others. These rallies, however, would not reach anything like the heights of the Gamestop squeeze. This incident was a one-off. The outcomes were very large and caused huge losses and gains to all the parties involved. The aftermath rocked the stock market creating a mini-crash and decline in the market as firms had to close on positive positions after this just to be able to sustain their short positions.
Paul Nawfal’s contact details: