What's a Short Squeeze ? - GME
Hello everyone ! The first month of the year is coming to a close, and there has been a lot of crazy action in the market, from companies making new highs, to retailer investors showing their gritiness with the likes of Gamestop. In short today's post will go over and uncover a question a lot of you had held , "Why is Game Stop (GME) going up so much? " So let's get started.
To start let's identify the 2 most basic ways an individual can make money in the market. The first is buy buying low and then selling the stock at a higher price (ex buying stock X at $10 and selling at $15). Ideally you go in buying at $10 and then expecting the stock to go higher , and you can keep the difference in profit from buy to sell.This one is fairly common and the one everyone is , for the most part, aware of. Now to get to the fun stuff, most new investors, or people who haven't dealt with the stock market don't know that you can also make money by betting against the stock, shorting a stock, or in other words , you can make money off a stock if it goes down ! This is called shorting.
WHAT IS SHORTING ?
Now to put it in more basic terms. Say you believe stock X is a bad company and its stock price is to high. So you can place a bet against the stock. Say stock X is trading at $50 and you believe it will go to $10. You can place a short position on the stock. In this case you borrow 100 shares of stock X from the brokerage , with the brokerage expecting you to give them their shares back by , say a month from now. So now the brokerage gives you 100 shares of stock X , you can immediately sell them into the market at $50, and since you sold 100 shares, you have $5,000. Now let's fast forward to a month from now, and assume that stock X did go in your favor and its lower now. Say it's at $25. Now since you still owe the brokerage 100 shares , you buy back 100 shares of stock X at $25 a piece , or $2,500 total. If you recall , you originally sold the shares for $5,000 , and now you bought them back for $2,500, so their is $2,500 still left over, and that extra cash is now your profit !
RISK WITH SHORTING ? With that said , shorting a stock posses unlimited risk, and should be done very cautiously. when you buy a stock for $10, the most you can lose is $10, you can never lose more than your initial investment when buying a stock, because it can't go lower than zero. On the other hand, when you short sell a short, your risk is technically infinite, because a stock technically go "to the moon" or keep going up (aka GME). Say you took a $10 short position , and the stock jumps to $21 , great you now down $11 , more than your initial investment. This is where a short can "cover his short", or buy the share back, give it back to the brokerage and take his loss. )This is why i prefer put options instead, because theirs limited risk and you can make money when a stock goes down 😯) (Discussed in : https://www.truetradellc.com/post/options-for-day-trading )
MARGIN CALL / STOPPED OUT
This will cover how a brokerage handles short positions to reduce their risk, and keep it minimized. As discussed when a short position is taken, the risk is unlimited, and to avoid the brokerage from taking on extra risk, they are allowed to initiate a margin call or auto sell an individual's short position if they are too much in the hole or close to 100% loss . (This information is made aware to investors before they enter a position). Say in the example above, you took a $10 short position and the stock now popped to $18 , you are now down $8 or 80%.(For the sake of this example just assume you only have $10 in your brokerage account) . Since your down 80% and you have no more money in your account the brokerage will initiate that margin call and now there are 2 things you can do to cover the margin call. You can either add more money into the short position ,(ex adding in another short for $18 , making your total short 2 shares at an average of $14 or $28 total) or if you can't add in more money you buy the share at $18 , return the share to the broker and take your $2 loss. This second move adds more buying pressure which can help expedite a short squeeze, which will be discussed in the next section.
How Does this Connect with Gamestop (GME)
Alright , now to get to the fun side, why is GME going up sooooooo much. Now that we know the basics of shorting, and what a margin call is, we can take a look at $GME and what occurred. $GME had a short interest of about 99% when this whole situation began , or in other words for every 100 shares GME had available to trade in the market, 99 of them where being shorted. When investors began to buy GME stock a few weeks ago, they realized that if enough shares were bought they could start triggering those big hedge funds to either sell their shorts on GME or keep adding in more capital to avoid having to sell. SInce these hedge funds didn't realize how gritty these retail investors could be , they kept adding size into their shorts as they usually are the ones with enough money to move the market. Slowly as momentum started to pick up and more individuals began buying $GME, their then came a point where these $GME shorters, aka the big hedge funds, had to cover , meaning buy shares, which adds more buying pressure + the buyers who are already pushing the stock up. And after the shorts exited their short position , they kept trying to short at a higher price, and the same thing happened. The buyers began pushing the price higher and higher, while the shorts began having to add size or cover their shorts after getting hit with margin calls. It basically made a positive feedback loop for the longs, as every time they pushed the price higher, more shorts had to cover (aka buy the stock) which in result pushed the price even higher, causing even more shorts to cover (aka buy the stock) and the loop becomes a SHORT SQUEEZE ,because as the name refers to , the shorts get 'squeezed out of their positions'. As a result $GME went from just under $4 just a few months ago , to now hitting over 513 in the pre market hours on 1/28.
WHAT SHOULD I DO?
To be fair, if your not already in $GME , I would advise you to leave it , the train's already left the station , and although there's still a chance we go higher, there's also a chance we head back down. As discussed every time , we always want to allocate or money into trades with the best risk reward. At this point , unless you understand the full risk of what your doing , stay away !!!! (Especially if you are a new trader). Yes many people have made money on it and the fear of missing out may be getting to you, but there's always going to be another trade. At the end of the day it's your decision on what you want to do , but as always we will provide you with info to make the best decision possible.
In terms of the other meme stocks (as WSB likes to call it), there are chances that they pump and squeeze, but with what happened with $GME, im pretty short the short sellers on those stocks will be much more cautious this time around .
Hope this helped decipher some of the questions you guys had, and drop any questions you have below !
Stayed tuned for this upcoming week's watchlist 👀 (will be posted 1/31) !!!