What's Going on With GameStop?

As GameStop's share price soars, we explain what a short squeeze is and how it works

Karen Wallace 28 January, 2021 | 9:19AM

shorting

Shares in US electronics retailer GameStop have exploded over the past few days. After trading below $20 per share for most of December and the first few weeks of January, it’s now trading at well over $300 per share.   

And it’s not just GameStop - it’s also cinema chain AMC and clothing retailer Express, among other stocks with ailing prospects. Why are these shares suddenly soaring? The coronavirus pandemic has wreaked havoc on movie theatres’ profits as well as those of bricks-and-mortar retailers. There wasn’t much positive news from these companies or fundamental reasons for the increased demand for these stocks. 

So what’s happening? It’s a classic short squeeze, but this time, Reddit-style.   

How and Why Do Investors 'Short' Stocks?

When someone shorts a stock, they’re trying to sell something that they don’t actually own because they think they can make money later by buying it back at a lower price. Hedge funds do this a lot, but short-selling can be very complicated and risky for individual investors to attempt.

Here’s how it works: If you believe a stock’s value will increase over time, you want to buy it and hold it, which is known as taking a “long” position. But if you anticipate that a stock’s price will decrease, you could take a “short” position. To do this, you would borrow shares of the stock and sell them to another investor (even though you don’t own them). If you can sell the stock to that new investor for a higher price than what it will cost you to purchase the shares from the original owner to cover your borrowing, you will profit from short-selling.

If the stock’s price keeps rising, though, the short seller will have to repay the borrowed shares at a higher price than they sold the shares for. Because stock prices can (in theory) rise indefinitely, short-selling can lead to potentially unlimited losses. With a long position, by contrast, an investor’s potential gains are unlimited but the most you could lose is 100% of what you invested.  

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Karen Wallace  Karen Wallace is an editor with Morningstar.

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