Roughly five months ago, I started getting mildly interested in a company that I was familiar with because of my hobbies (namely video games), but had never been on my investing radar: Gamestop (GME).

The reason I had started getting interested wasn’t because of the normal reasons I get interested in investing in a company. I didn’t see Gamestop as some kind of disruptive and innovative company which would see huge growth over the next 3+ years. To the contrary, Gamestop seemed like a bit of a dumpster fire. It was a brick and mortar retailer primarily dealing with goods (video games) which were quickly making a transition to digital. Few companies seemed worse positioned to deal with the future.

So why was I interested? For three main reasons:

• While the business was undoubtedly in decline, the company wasn’t in danger of imminent bankruptcy. They weren’t saddled with huge amounts of debt that were about to come due which they couldn’t pay off. They had cash on the balance sheet and were still making money.
• There was a console refresh (new versions of the Playstation and Xbox consoles) in the upcoming holiday season (December of 2020) which typically provides really good results for Gamestop. Consoles, unlike games, still largely are bought in store.
• There was an insane level of short interest (over 100% of the float).

That last point was the most important. Basically, for as bad of a position as Gamestop seemed to be in, the sentiment looked to be a little too negative. I thought there was a potential opportunity to make a short term bet (and I stress that this would’ve been a bet, and not investing, which is what I typically like to do) that the stock might see a little pop and maybe even a short squeeze after they reported holiday season results.

I looked in to doing some options, but ran into some issues getting permissions set up with my broker and by the time I was able to make my bet, the stock had gone from around $5 a share to around $8 a share. I thought I had missed my opportunity.

Obviously, I was wrong.

Despite that, I have absolutely no desire to come anywhere close to touching Gamestop stock right now. The stock price is completely detached from reality right now and the wild swings have nothing to do with business fundamentals and instead everything to do with a fight between a bunch of retail investors and hedge funds. What is going on is very interesting and even pretty important, but I have no desire to try to profit off of it in any way.

In my opinion, taking any sort of position in Gamestop at this point is not very different from playing a roulette wheel. Maybe you get lucky and it works out, but you’re just as likely to get unlucky and get burned. I’m happy it has worked out for many people, but I worry that plenty of others are going to get burned and are going to swear off “investing” forever, even though taking a position in Gamestop right now is the opposite of investing to me.

This blog wasn’t intended to giver personalized advice and I never have wanted to tell people what to do, but I do want to stress to everybody to please, please, please be careful with anything involving Gamestop or any of the stocks making crazy moves right now (looking at you, AMC). There is a very good chance that these stocks return back to the levels they were at a few weeks ago (or even lower) and it can happen a lot faster than you might think.

Related: I’ve had a few people ask me what is going on, and after writing it out a few times over emails and discord channels, I figured I might as well write something here that I could instead point people to.

What’s the TLDR? What happened to Gamestop shares is the mother of all short squeezes plus a really fascinating battle between a bunch of retail investors who decided to pick a fight with some hedge funds.

For more detail, we have to understand what a short squeeze is first:

What is shorting?

Shorting can be thought of as the opposite of “regular” investing. Here is the “normal” order of operations for a hypothetical investment:

1. Buy shares of a company for $5 a share
2. The price per share of the company goes up to $10 a share
3. Sell the shares for $10 a share and make $5 profit for each share ($10 made from selling minus $5 paid to buy)

Here’s how short selling might work for a hypothetical investment:

1. Sell shares (that you don’t own) of a company for $5 a share by borrowing shares from somebody else
2. The price per share of the company goes down to $1 a share
3. Buy shares for $1 a share so you can return the shares that you borrowed and make $4 profit for each share ($5 made for selling minus $1 paid to buy)

The cool thing about “normal” investing (often called being “long” as opposed to being “short”) is that your downside is limited but your upside is unlimited. For example, if you buy a share for $5, then the most money you can lose is the $5 you paid for the share. But if the share price goes to $100, you can make $95. If the share price goes to $1,000 then you can make $995. That kind of asymmetrical risk/reward is part of what makes investing so appealing to me.

Shorting is the opposite. In the example above, if you short a $5 stock then the most money you can make is $5 a share. But the most money you can lose in theoretically unlimited. If the stock doesn’t go down, but instead goes up to $100, then you have lost $95 on your $5 investment. That kind of asymmetry is a lot more dangerous and is why I never consider shorting.

What is a short squeeze?

Short squeezes happen because of the danger of potentially unlimited losses. Go back to the example above. If somebody shorts a stock at $5 and the stock price goes up to $10, they have now lost $5. The more the price goes up, the more that position loses. So if the price goes up enough, some short sellers might throw in the towel and decide to take their losses and run. In order to close their position out, they need to buy shares in the company to return to the person they originally borrowed shares from (see #3 above in the short example). When those people buy shares to close out their position, that buying activity drives the share price up more. So instead of that ideal short situation that was described above, here is what happens instead:

1. Instead of going down like shorts expect, shares of a company go up
2. Some people who were short the stock panic over losing money and close their position out by buying shares
3. The act of buying shares causes the share price to go up even more, causing more shorts to panic and close out their position
4. Go back to #3

As you can see, this can snowball in a hurry and cause a major increase in share price very quickly. That’s called a short squeeze.

So what happened?

As mentioned before, the short interest on Gamestop was crazy high. At one point it was over 100%. This caught the attention of a group of investors. There were a couple of different names being used to describe them: Wall Street Bets (WSB), Robinhood investors, retail investors. The important thing is that they were coordinated. They noticed the opportunity for a short squeeze in Gamestop and decided to try to trigger one by buying a bunch of shares. Their motivation seems to be two-fold: to make money, but also to stick it to hedge funds that they see as having manipulated the market and hurting the little guy in the past.

They seem to have been wildly successful so far.

As the short squeeze was being triggered, it seems like the hedge funds underestimated their opponent at first. After all, if you thought Gamestop was a compelling short at $5 and nothing fundamentally has changed in their business, then it has to be an incredible short opportunity at $50 and higher! So instead of cutting their losses, it looks like some hedge funds might have doubled down. The thing with doubling down on short positions, though, is that if the price keeps going up, then it just ultimately worsens the short squeeze.

And remember the asymmetrical risk/reward with shorting? A hypothetical hedge fund with a $1 million short position in Gamestop at $5 a share, if they still held their short position, would now be looking at tens of millions of dollars in losses. That is something many of them might be having trouble weathering, and there are rumors flying about some hedge funds needing to raise money, sell shares in some of their long positions, or even facing bankruptcy.

This is only scratching the surface, and isn’t even getting into all the funny business around brokerages like Robinhood preventing people from buying (but not selling) shares of Gamestop yesterday. The story is still playing out, and it is a fascinating one.

But it is also one I am very content watching from the sidelines.