Why GameStop Stock Rocketed to the Moon

GameStop (GME 2.19%) has been in the headlines lately, but not for a new gaming console or a can't-miss after-holiday sale. It's all about the incredible rise of its stock, which has shocked the investing community. The shares have been the focus of a small group that decided to manipulate the system and stick it to big investment funds. What happened next is a fascinating story.

On the "Mindset" show from Fool Live on Jan. 27, Motley Fool analyst Tim Beyers dives into detail to explain what caused this retailer's stock to rocket beyond earth's orbit, bound for the moon. 

Tim Beyers: I want to break something down a little bit here because, Brian, you just touched on it, it's the fear of missing out here. What I think is, in many cases, what is happening is you have two things going on. Let's talk about technically what's happening with GameStop and AMC Entertainment Holdings (AMC 2.45%). We'll start there. What's technically happening is both of those stocks had really high short interest. You have lots of big hedge funds that we're betting against the stock, they were borrowing shares in order to profit when the stock fell because they really didn't think these businesses were very solid, so huge short interest. So what's happening on this subreddit that's called WallStreetBets is there seems to be some orchestrated campaigns that said, OK, here's what we're going to do. We're going to buy shares and we're going and credit to Bill Mann on this for explaining this. He has a Facebook post on it that really explains this in great detail.

Basically, what this campaign is orchestrated campaign is like we're going to buy a bunch of shares. Then what we're going to do is prevent the brokers who hold our shares from lending out our shares. Can't lend out our shares anymore. We won't allow that. You know, you have the right to do that. No, can't borrow my shares, can't short them. So what ends up happening is you create some artificial demand for the stock and the stock starts to go up.

So what happens? These hedge fund short managers, it's like "oh no", I need to cover my short here because this stock is moving against me. But there are no shares for them to buy so they can cover their short. Because when you're short, in order to close the short position, you have to buy back shares. But what if there are no shares to buy? What if a bunch of investors said I'm not going to allow you, I'm not going to sell my shares to you. And not only that, but you can't borrow my shares to short again.

So now you've created this artificial construct. So the stock just goes to the moon because the supply and demand mechanics are completely out of whack. That's blown apart. So GameStop goes to the moon. AMC goes to the moon. There were some questions about, well, this wouldn't really happen to any other stock, like in the [Motley] Fool universe. Not true. There are a lot of stocks in the Motley Fool universe where there are really high short positions, real lots of short interest. Any stock where there's a really high short interest, this could happen.

Now here's the really insidious part, is some of these hedge funds now, in order to stay liquid, they go and borrow money. They raise new capital, but they raise it at really unattractive rates. So what ends up happening? The middleman, in this case, a company called Citadel, which had access to seeing all the order flow on Robinhood can see what's happening here and offer some money to the hedge fund. Yes, sure. We'll give you some more money here at these really unattractive terms, but you don't really have any other choice. So who's the crook here? I mean, I don't know who the crock is. I'm not going to call anybody a crook, but what I know is that it's a broken system and this can be repeated.