WTF Happened with GameStop?

I think it’s fair to say that the biggest financial news so far this year (at least if you measure news-worthiness by how many memes are made) was GameStop…where an online flashmob virtually came out of nowhere and changed the financial game.

Exhibit A:

Exhibit B:

Exhibit C:

I rest my case.

When the GameStop stuff went down (or rather, up), I can’t even tell you how many DMs I got asking what the fuck is going on. And later, how the fuck could that have happened? The answer to both of those questions really comes down to an understanding of what it means to short a stock.

Normally when you buy a stock outright, the old adage, “buy low and sell high,” works. But when you’re shorting a stock, you’re hoping to buy high and sell low, and that’s how you make a profit.

I know you may be thinking, Okay, buying high and selling low… that sounds like a loss to me. But here’s how to think about it: Say you borrow my car (you’re welcome, boo!), and as soon as you pull out of my driveway, you post the car on Craigslist and sell it. For easy math, let’s say you sell it for $10,000. That $10,000 is now in your pocket (you’re welcome, boo x2!).

Then, you wait. You wait because you’re betting that the cost of the car will go down once a new model comes out. So until the shiny new year, new me model comes out, you’re sitting pretty.

Let’s fast-forward. After a year, let’s say the value of my car (yep, the car you sold) goes down to $8,000. This is the moment you've been waiting for. You buy that car, which is the very same make and model that you borrowed from me and sold at $10,000, but now you’re buying it back at $8,000. Then, you give the car back to me, you thank me for letting you borrow it for a year (I really am the best), then you’re able to pocket the $2,000 difference.

That tricky maneuver? That’s essentially what it means to short a stock. Now, let’s put the example in context.

Even though shorting is confusing, I think we’re all clear that shorting a stock is different from buying a stock outright. When you buy a stock, you put money down to own that stock, and then you own it. The end. You hope that the value of the stock goes up, because then, you can sell the stock for more money than you bought it for and make a return.

But when you short a stock, you’re not actually buying the stock. You’re borrowing a stock from a broker. Like the car example, right? But unlike the car example, you’re not borrowing a car from me, you’re borrowing a stock from a broker. Then, you’re selling the stock at value because you’re betting that the value of that stock will go down. When it does (or rather, IF, it does), you want to buy the stock back at the new-and-improved lower rate, return it to the broker, and pocket the difference.

But, as you’re probably sensing, and as GameStop showed us, this is extremely risky for you, AKA the investor, who is shorting the stock. And that’s another difference between shorting and buying a stock.

Remember - the rules don’t change no matter how you invest. A stock can only go down to zero, but it could go up without limit.

When you buy a stock, you’re betting the value of the stock will go up. When buying a stock, the worst case scenario is that the company you invested in, fails. You would then lose 100% of the money you invested. That totally sucks.

But when you short a stock, the worst case scenario is so, so much worse. Remember, a stock could go up without limit, but you’re betting the stock will go down. Let’s bring back the car example. You sold my car for $10,000, right? Well, what if this make/model jumps in price. Say, some celebrity bought this make model and now the car is being valued at dealerships for $100,000. Then I call you and I’m like “Hey, no sweat that you asked to borrow my car for one weekend and it’s been 52… but, I actually do need it back, so can you drive it over tomorrow?” Well, then you have to buy my car back at $100,000 when you sold it for $10,000; meaning, you just lost $90,000.

And, that’s what happened with GameStop. The hedge fund bros had bet that the value of GameStop was going to go down. But then, out of nowhere, a band of people on the Reddit thread WallStreetBets drove the price of GameStop up and up and up.

So then, when the brokers who had lent the GameStop stock to the aforementioned hedge fund bros came calling, the hedge fund bros were shit out of luck; they needed to run out and buy the GameStop stock back, but the value had gone up astronomically.

Lots of people asked me why the financial world was so upset during the GameStop debacle. And, first, I have a correction: the financial world wasn’t upset, these hedge fund bros were upset because they are sore losers… and they lost at their own game.

Many people also asked if I thought Redditers were doing something bad. My answer? Hell-to-the-no! Investors have autonomy to make their own decisions about how to invest. That is the whole point of a free market. The market can’t be free only when it works for these hedge fund bros, and restricted when it works for the rest of us.

But a word of caution: a GameStop phenomenon is extremely rare. Case and point; GameStop dominated the news cycle for so long because an underdog disruption practically never happens in the stock market. If you’re looking for someplace to invest, don’t chase the next GameStop. Instead, look out for my upcoming newsletter titled Index Funds and Chill. I’ll give you the 411 on how to invest like a Rich Bitch.

For now, our Money Minute is up! Until next time, don’t do anything with your money that I wouldn’t do!

xo,