Buying stock is typically a carefully-researched decision based on the long-term viability of a company. In recent days, however, the hottest stock on the U.S. market was a struggling, brick-and-mortar video game retailer -- not exactly a business model that suggests explosive growth or even long-term viability.
How, exactly, did this happen and why? Through a series of unlikely events, GameStop (GME 1.42%) became a "meme" stock, with small investors driving up the price by creating a big buzz on social media.
Still confused? Since social networks helped send GameStop's shares skyrocketing more than 1,640% at its peak, why not let one of them -- Twitter (TWTR 1.51%) -- explain just what's going on.
Twitter explains GameStop
The GameStop saga all started in a Reddit subforum called r/wallstreetbets.
See, around a year ago, the founder of r/wallstreetbets published a book containing a warning for Wall Street. He cautioned that the industry's business model might not stand up to groups of retail investors who could harness the power of the internet to exploit weaknesses.
And that's exactly what happened. Reddit users, who were bullish on GameStop, noticed a whole bunch of hedge funds had shorted the stock, meaning they made big bets on its price going down.
Redditors decided to execute a "short squeeze," buying up stock and harnessing the power of social media to encourage others to do the same.
The regular people are the apes and the hedge fund people are the snakes in the analogy pic.twitter.com/Fpcu18Myl9— SteveyJ (@ImSteveyJ) January 27, 2021
As hordes of retail traders bought GameStop stock, the price of shares skyrocketed.
Hedge funds had to cover their shorts by buying shares, which sent the price up further -- and Elon Musk amplified the whole thing.
Gamestonk!! https://t.co/RZtkDzAewJ— Elon Musk (@elonmusk) January 26, 2021
Hedge funds started to suffer big losses, with some requiring bailouts.
Financial markets suffer for a second day from investor activists targeting hedge funds. Yesterday GameStop made Melvin hedge fund realise losses of $5 billions after Reddit pushed shares higher when Melvin was betting on a decline.— Mohsen Derregia (@MohsenDerregia) January 29, 2021
The story took off, with even people outside of the financial world jumping on the bandwagon -- if not by buying stocks, then by cheering on what they saw as a takedown of Wall Street bigwigs by everyday people.
Your hedge fund collapsed? Sorry to hear that sir. I'm afraid I'm not authorized to give discounts- that'll be $18.95 pic.twitter.com/Xjq6aikatl— Delicious Tacos (@Delicious_Tacos) January 27, 2021
Unfortunately, many people who jumped on the bandwagon and bought GME may not have been fully aware of the risk they were taking on -- which was a big one. Warnings flooded in about the volatility of the investment.
Look gamestop stock can go to $1000 tomorrow or it can drop to $50. Please be careful with your money lol— ZeRoyalViking (@ZeRoyalViking) January 26, 2021
But people just kept buying.
Riding the GME meme train... to the moon! pic.twitter.com/RKgKiEoqKa— Joey Ferrito (@1919Hogger) January 26, 2021
And started expanding their purchases to other stocks they thought had potential to execute a similar short squeeze.
GameStop, BlockBuster, Bed Bath & Beyond, AMC... it's like some kids remembered their favorite places in the mall 20 years ago and decided to invest in them pic.twitter.com/QOB8vLtOKk— Mike Murphy (@mcwm) January 27, 2021
As the stock price soared, however, some brokerages -- most notably Robinhood -- halted the ability to freely trade GameStop shares.
Robinhood got a lot of flack for this choice, most notably because it's an incredibly popular platform among the types of traders most likely to be participating in the GameStop frenzy.
This is so messed up @RobinhoodApp!! I'm limited and can't buy more than 1 share, so I try a fractional share and that's not available either? What happen to the free market?? Let the people trade! $BB $GME $AMC #DOGE pic.twitter.com/tw0kgZ3nB9— Ben J (@DeepSpaceBen) January 29, 2021
Lawmakers from both sides of the aisle also voiced their concern about why Robinhood stopped trading.
Fully agree. 👇 https://t.co/rW38zfLYGh— Ted Cruz (@tedcruz) January 28, 2021
It later turned out the broker may have halted trading because it couldn't afford to let people continue buy GameStop on its platform, due to certain Securities and Exchange Commission (SEC) rules.
So it looks like Robinhood did not prohibit customers from buying GameStop or AMC as part of a conspiracy to protect short sellers. It did it because it literally couldn't afford to let them keep trading.https://t.co/0uFya2zDjr— James Surowiecki (@JamesSurowiecki) January 29, 2021
Of course, the SEC took notice.
"we are working with our fellow regulators to assess the situation and review the activities of regulated entities, financial intermediaries, and other market participants." https://t.co/P3IMlwB62h (2/2)— SEC_News (@SEC_News) January 27, 2021
And some Wall Street insiders decided to make some changes.
Citron Research discontinues short selling research After 20 years of publishing Citron will no longer publish "short reports". We will focus on giving long side multibagger opportunities for individual investorshttps://t.co/gP9HXzo7Nf— Citron Research (@CitronResearch) January 29, 2021
While this may all seem fun, a lot of regular people could end up suffering huge losses.
$GME closing price yesterday was $347.51.— The Wealth Dad (@thewealthdad) January 28, 2021
A $10,000 investment into $GME at yesterday's closing price would now only be worth $5,700.
Regardless of the reason why, this is why you don't trade off short-term hype.
In these instances, there's A LOT more losers than winners. pic.twitter.com/zHuoetr7EQ
Which is why it's probably best to avoid taking stock advice from Reddit.
Idk why people are freaking out regarding taking stock advice from Reddit when the same people use WebMD....— caroo (@Caroo1211) January 28, 2021