When buzz of a Reddit group called WallStreetBets started popping up in the peripheries of my social feeds, I ignored it. It felt false and scammy. I didn’t see it as being of any more use to me than Motley Fool has ever been. But when the shit hit the fan and major news outlets began reporting on GameStop’s meteoric rise, I got curious. I started following WallStreetBets in Reddit.
In a former life, I was a financial planner with a securities license. My IRA has been flagged by my account custodian as a day-trading account. I’m not a regular day-trader because day-trading is risky and requires dedicated focus, and I have an actual, dependable day job I have to do. On occasion though, if the market is having an especially volatile day, I will set aside some time to hunch over my computer and do bad things to my blood pressure in the interest of growing my retirement account.
On Thursday, January 28, I started my morning by watching a few of the stocks in question — GameStop, AMC, Blackberry, Nokia — while simultaneously following the chatter in WallStreetBets. The stocks were tumbling 30 to 50% after a meteoric rise the day before, but in the Reddit group, people were still talking about them, still very excited. Hedge funds were still in the process of buying back their shorted stocks, which, in theory, meant the price would likely be driven back up as they closed out their short positions. I had some cash in my IRA, which I can’t touch for 20 more years anyway, so I bought in, fully prepared to lose every dollar I invested.
What does it mean to “short” a stock?
Whereas most people think of the stock market as owning a piece of a company so that you can participate in its growth, shorting stocks is literally gambling, and it’s a type of transaction in which you never actually own the stock aside from the fraction of a second you have it before immediately selling it. You’re simply betting the company is going to lose value and/or the stock price is going to fall. You want it to fail.
Here’s how it works: Say I believe ABC company is going to experience a dip in the near future. Currently, the price of one share of ABC stock is $10. I don’t buy the stock. I borrow it, paying a small amount of interest (I am borrowing after all) and then I immediately take that borrowed share and sell it. Now I have $10 in my hand. I wait a few weeks, and sure enough, the price of stock ABC has plummeted to $6. Remember, I no longer have a share of ABC stock. I simply have $10. But I did borrow the share of ABC, and I do still have to give it back. So I take my $6 of my $10 and use it to buy back the stock.
Now I have $4 plus one share of ABC stock in my hands. I return the share of ABC stock to the person I borrowed it from, and I get to keep the $4 minus the small amount of interest I paid to borrow the stock. The only money I had to “invest” to make $4 was a little bit of interest. A few pennies. Say the amount of interest I paid was $0.50. So my profit was $3.50. That is a return of 700%. This is why hedge funds get so huge. This is how the rich play games to get richer and richer and richer.
Of course, shorting doesn’t always work. Imagine I was wrong about ABC stock. I thought it was going to fall, but it ended up having a surprisingly great quarter and the stock price rose to $15. In order to maintain my short position and guarantee I’ll pay back what I borrowed, I have to maintain a certain amount of cash in my account, called a “margin requirement.” The margin requirement gets higher and higher as a shorted stock’s share price rises, sometimes so high as to be untenable. Say I can’t meet the margin requirement at $15 per share. Now I’m forced to buy the borrowed share back for the higher price of $15. Remember, the moment I borrowed it, I turned around and sold it for $10. But now I have to add $5 of my own money in order to get ABC stock back so I can return it to the person from whom I borrowed it.
Now I’m in the negative $5. I didn’t just lose the $0.50 of interest I paid. I lost money I never invested to begin with. Imagine if ABC, by some freak, unforeseen situation shot up to, say, $300. Now I’m out $290 for a single share. What if I had shorted way more than one share? What if I’d shorted 10,000 shares?
This is what happened with GameStop. A large group of small-time investors joined together to buy up shares of Gamestop and other stocks heavily shorted by hedge funds. The hedge funds could not meet margin requirements and were forced to buy back those borrowed shares at a price several hundred dollars higher than anticipated. Hedge fund managers had losses racking up to billions of dollars. I don’t feel even a little sorry for the hedge funds. It took an astronomical amount of hubris for them to leave themselves so exposed like that — investors can see how much a stock is shorted. Their egos, their greed, and their arrogance prevented them from imagining that retail investors could beat them at their own game.
What happened when I invested
Immediately after purchasing shares, my account began to shrink. My money drained away, and along with it the blood from my body. I told myself that if I lost half, I would cut my losses and sell. But then the prices began to climb again, incredibly quickly. For about an hour, I watched them climb, GameStop in particular occasionally halting trading because it was moving too fast. Around noon, no longer able to take the stress of watching the ticker, I sold everything. I made about $4,000. After I sold, the shares prices continued to climb. I calculated that, had I held and sold at the top, I would have doubled my gains to $8,000.
Nevertheless, the funds I invested saw a 33% gain in a single day. Typically, accounts take three years or more to grow that much. The truth is, though, I was lucky. I could have lost a shit-ton of money. Never in a million years would I have taken such a risk with a client’s money. The risk was calculated, sure, and it was in my retirement account which I can’t access and still has 25 years to recover. But still. A huge fucking risk.
And, despite the news stories about small-time investors taking down an investing Goliath, a lot of small-time investors did lose a shit-ton of money. A woman in her early twenties I know through Facebook mentioned in a comment thread that a friend of hers had bought at the top thinking it would keep going up, and then it crashed and he panicked and sold. He’d bet all the savings he had.
In WallStreetBets, mingled in with euphoric comments about massive gains are devastated comments from people who went all in and lost nearly their whole investment. Along with the hedge funds frantically buying up shares as they tried to close out their positions, there were a lot of regular Joes seeing the share prices rise and thinking if they didn’t get in now, they never would — FOMO investing.
These folks didn’t know they were buying in at the peak, that the stock price was about to tank. In the chats, many Redditors were predicting Gamestock shares would get as high as $1,000. Why not buy GameStop at $425 if you think you’ll double your money? When it tanked, though, the same people who bought in assuming it would keep rising also couldn’t imagine it ever coming back up again when they saw it precipitously fall. They sold and captured their loss.
We don’t see these stories as much. I think it’s because there is a certain shame that comes with betting and losing. There is even some shame in taking a risk that big in the first place. I told only one other person that morning that I was going to invest. I was terrified of having to answer the question “So how’d your investing go?” with “Um, I lost ten thousand dollars.” So I said nothing. If I suffered a huge loss, I’d cringe in secret for the rest of my life.
Good on this group of investors for sticking it to these greedy, hubristic hedge funds. Good for those who saw thousands of percent returns on their investments. But there were little guys that lost money too here, so be wary of FOMO investing. If investing in the stock market is something you’re interested in, take time to learn about how it works. And if you’re ever thinking of investing in a “trend,” just be sure you don’t invest one dollar more than you’re fully prepared to lose.
This article was originally published on