Short-Squeeze Targets the Stock Market

Tom Brown |

Recently, GameStop and AMC (also known as meme stocks) have been in the news due to their dramatic increase in the price, volume of shares traded, and volatility of their stock. The interest is caused by short selling and squeezing, two trading influences which have dominated headlines in the finance world this year mainly due to Reddit, a social news organization which publishes stock picks.

Short selling is when an investor borrows shares from another investor and immediately sells them. This allows an investor to take a position based on a bearish view of a stock. The short seller is betting that the price will do down and can be purchased back at a lower price in the future than they sold it for. Short selling is risky because the shares are borrowed and they are obligated to buy the shares back to return them to the owner. The danger is that there is no limit on how high the price of the shares could go that need to be purchased to satisfy the loan, therefore, there is no limit on the downside exposure of the short sale.  

A short squeeze is when a stock with a lot of short positions increases in price and the short sellers jump into the market to buy back their short position. With enough activity, this can drive the price up significantly, as we saw recently with GameStop and AMC. Fundamentally, there were bearish pressures on those stocks due to COVID and how consumers were watching movies and gaming. Many institutional investors will have stop losses in place on short sales, meaning if the price increases to a certain level, the short is automatically bought back to limit exposure. Additionally, those who follow Reddit view short selling as a “fat cat” way to game the market since most retail investors are unable to short stocks. Due to the shorting that was taking place with AMC and GameStop, Reddit listed these stocks as buys and their retail followers reacted. With AMC and GameStop, stop losses triggered buying, and together with the Reddit movement buying the stocks, their prices were driven up creating a short squeeze on these stocks.  

In December of 2020, GameStop was trading around $20 per share.  As of the day of this writing the stock price is over $200 per share. Short sellers have lost millions of dollars due to the rapid increase in its share price. In March of 2020, AMC was trading at a little under $5 a share. Today, it is trading around $50 per share. Like GameStop, AMC shares first went up after being targeted by investors on Reddit. As more and more retail investors got in on AMC, the stock price continued to rise.  As of June 2021, AMC was the most shorted stock in the market. Short sellers have lost billions of dollars on their AMC positions. These stock prices are very volatile and over time will likely trade on the fundamental strength of the company but until the Reddit following focuses elsewhere, short sellers should beware.