Gamestop is one of the hottest stock in the news right now, But should you jump in How did thestock suddenly go up two thousand percent Was it? Really just retail investors buying it allup?
It’s not that simple Let’s see how thisexplosion happened, We see that in a monthGamestop shot up one thousand six hundred percent.
But at the highest point. It went up almost twothousand five hundred percent.
This is a story. Ofhow retail investors were able to beat Wall Street.But. How did they come up with? So much money Well, actually, it’s not that simple!
These retailinvestors served as a catalyst for the explosionin price that happened afterwards from a feedbackloop that happens in the stock market.
Confusing enough, Let’s get into it These retail investorssaw that a lot of people on Wall Street wereshorting, Gamestop So you can think of shortinglike us going to the bank to borrow money oninterest.
However, instead of borrowing, money, they’re, borrowing, a stock on interest and thenselling that stock to someone else at the marketprice For example, ten dollars and hoping the price will godown so that they can buy it back at a lower pricein, the future, For example, five dollars and thenearn the difference.
So in this case they wouldhave earned five dollars. Excluding any interestfees which we don’t need to go into right now In this situation you have a max gain of tendollars.
If the price falls all the way to zero Butif, the stock goes up, then you have an unlimitedamount of loss because at the end of the day, youhave to return that piece of stock back to thebrokerage.
So you got to buy it back at whateverprice. It is at the moment, For example, if the stockgoes all the way up to 20 dollars, you lose 10 dollars per shortposition.
There’s two important concepts we needto cover in order to understand what happened.First the price of a stock is driven by supplyand demand.
So if there are more sellers, thenthe price will go down and when there are morebuyers, then the price will go up.
Second there’sa term called margin call and in this situationit means if the price goes up too much, then thebrokerage can force you to sell because you don’thave enough money to cover your losses.
Anymore.Because remember you are borrowing the stock Asthe retail investors buy Gamestop, the Gamestopprices will move up because there are more buyers.That forces.
The people who shorted Game Stop because they are hoping to earn money from thestock price falling to have to buy the stock toclose their short positions to cut their loss.
Inaddition. The brokerage firm will force tradersout of their short position as a margin callthat. I explained earlier if the stock pricegoes up too high, and they don’t have themoney in their accounts to cover the losses.So.
As these three things happen, resulting inpeople buying more and more stocks. It drivesup the price higher and higher at a faster pace.And. As a result, this is a snowball effect. However, that’s not even the whole story.
Another way toearn money on the price increase is by buying calloptions Without going too detailed. It’s a contractthat gives you the ability to buy the stock at acertain price, for example, twenty dollars evenif the stock went up to a hundred dollars.
So people who buy these call options will earnmoney when the stock goes up. However, again inthe market there has to be a seller in orderfor you to be able to buy one of these options.
Just like in life, there has to be at least twopeople involved when there is a contract Usuallyit’s, a market maker which is a person managingthe market.
So for understanding sake, we can callthem the manager of the market. Who is willing? Tosell you one of these contracts for you to buy. Now when they’re selling you a contract.
Their risk is pretty much the same as when someoneshorts the stock that I explained above, which isunlimited risk However, their goal is to minimizerisk, So what they do is when they have tosell one of these contracts for you to buy, they would buy shares of the stock to reducetheir risk.
Which in turn drives up the stockprice because there’s more buyers As a result, when traders see that Gamestop price is movingup, they want to buy more call options.
Result ingin, a manager of the market to buy more stocks, making the stock go up even higher creatinganother feedback loop. So you can see herethat, it’s retail investors driving the priceup, which forces the short sellers to buy backstocks to close their position, which drivesthe stock up even more.
This snowball effectpushes stock to a certain price where the playerswho are still short. The stock will be losingso much money that the brokerage firm will forcethem to close their position by buying back stocks.
Which you can’t say no to, if you don’t haveenough money to cover your losses, You can seethat happening on the chart where the growth wassmall to begin with, and then the price startedincreasing more and more every day at a fasterand, faster rate until it just blew up.
So theseretail investors really sparked a huge effect, thatjust spun itself out of control. In the long term, the stock will go back to its fundamental value.
Which. According to seeking alpha is around 60dollars However, it doesn’t mean you should get inon this stock because in the short termanything could happen and the market can movein crazy directions.
From this event, it’s a realreminder of the risk people need to consider. Whenthey short, a stock Doesn’t mean shorting is bad, but it just means that you need to know therisk in every trade you take and how to managethat risk.
Also, it’s really interesting becauseusually. When you buy a put option, you make moneywhen. The stock price goes down.
Some peoplehave been losing money on their put optioneven as the stock price went down by a lot.
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