GameStop stock is anticipated to experience a significant increase of 70% when markets open this morning, while AMC shares have already risen by 300% upon opening, continuing a trend that has surprised market analysts, frustrated hedge funds, and overshadowed recent gains seen in the cryptocurrency sector.

Traditionally, individual retail investors have often faced disadvantages, attempting to succeed in the markets without the resources, information, and access available to professional traders. In fact, many professional investment funds available to the general public fail to outperform the overall market. This is a key reason for the growing popularity of index funds and other passive investment strategies that simply mirror broad market performance; why pay higher fees for potentially lower returns than achieving the same results as the S&P 500?

However, the landscape has evolved in recent years. Robinhood has revolutionized trading fees, and alongside similar platforms – such as Public.com with its social features, and Freetrade in the UK – has made investing more accessible to a wider audience. Coupled with increased time spent at home, and the influence of a vibrant online forum, a previously niche online community has gained widespread attention after its members began to exert their collective influence.

This development was highlighted by Reddit founder Alexis Ohanian, who shared his observations on Twitter.

The practice of traders sharing tips and attempting to inflate stock prices in online chat rooms is not new, dating back to the dot-com boom. However, the combination of established social media platforms and commission-free trading has simultaneously broadened access to the financial markets and provided a more streamlined way for individual investors to coordinate and impact outcomes.

Ohanian’s perspective on this phenomenon is noteworthy.

“For hundreds of thousands of years, human beings have been conditioned to trust and support the immediate groups around them. The concept of an ‘institution’ – a faceless, nameless entity requiring trust – is somewhat unnatural to our species,” the venture investor explained on Twitter. “I recognize they are often described as ‘random people on the internet,’ but there is a considerable amount of empathy and community present, more than many realize. This is why I’ve maintained for 15 years that (online) community remains significantly undervalued.”

This dynamic has played out with GameStop, a company that, until recently, was largely unremarkable, grappling with a traditional brick-and-mortar retail presence, the impact of the pandemic, and a shift in consumer preference towards digital game purchases. The stock traded around $4 per share last summer, began 2021 at approximately $18, and currently stands at $147.98 after a 92.7% increase yesterday, with a further rise of $69.02, or 46.6%, this morning.

This surge wasn't due to a sudden improvement in the company’s fundamentals. Instead, a group of Reddit users discovered that GameStop was subject to short selling exceeding 100% of its available shares, meaning investors had bet more shares would decline in value than actually existed.

While a high short interest is not uncommon, exceeding 100% was unusual.

This led to a strategy: if a substantial number of individual investors began buying the stock, it could drive up the price, forcing hedge funds and other large investors to either maintain their losing short positions as GameStop’s value increased, or “cover” their shorts by buying back the stock at a higher price, resulting in financial losses. Covering shorts would necessitate purchasing the stock at elevated prices, potentially further boosting its value.

This has resulted in an exceptionally significant short squeeze.

There is inherent tension between short-sellers and those who bet on rising stock prices. Short-sellers are often viewed negatively, and the term perma-bear, used to describe someone consistently pessimistic about asset prices, is frequently applied to them.

However, a growth in retail investing combined with social platforms facilitating the connection of individual investors has proven to be a powerful force. Consequently, users of the WallStreetBets sub-Reddit began purchasing GameStop stock, and continued to do so, driving its price higher and higher.

As a result, large investment firms have incurred substantial losses on their short positions. CNBC reports that short-sellers have lost over $5 billion so far due to GameStop’s rapid price appreciation, fueled by its status as an internet phenomenon.

The battle between professional investors anticipating a decline in GameStop’s price and retail investors driving it upward is ongoing. Short interest remains substantial, meaning that even if some investors have closed their positions, the potential for further gains – or losses – remains. GameStop has a greater distance to fall from its current price than it did from its previous levels.

Predicting future market movements is impossible. Investors who have increased their short positions during the rally are likely to face losses when GameStop opens higher this morning. They may choose to hold their positions, hoping for a future decline, or retail investors may continue to drive the price upward, with an uncertain ultimate outcome.

While many individuals have their retirement savings in conventional, often overlooked investments, small-time investors are challenging the established financial order. This reflects a broader political sentiment of frustration with perceived unfair practices and a desire for greater control. The GameStop situation, to some extent, represents a form of retribution.

However, this may not have lasting consequences. Large investment groups will likely continue to outperform retail investors due to their superior access to information and resources. Nevertheless, today, those same concerns are beginning with significant paper losses on their GameStop short positions.

And that is remarkable, given that the company is demonstrably overvalued and individual investors appear unconcerned.

1. I, Alex Wilhelm, experience this before having coffee.