Learn from the GameStop Frenzy with This Quick Guide to Short Selling

Mandatory Credit: Photo by Evan Agostini/Invision/AP/Shutterstock (10667337b)ThinkGeek and GameStop stores on Broadway show signs of damage after a night of looting and and social unrest following George Floyd police brutality protests in Manhattan, in New YorkNYC Looting Aftermath, New York, United States - 02 Jun 2020.
Evan Agostini/Invision/AP/Shutterstock / Evan Agostini/Invision/AP/Shutterstock

Controversy ensued this week when GameStop (NYSE: GME) skyrocketed this week after a group of retail investors on a Reddit sub-thread called r/WallStreetBets targeted the stock for a short sell (followed by the news that Robinhood, a retail trading app, how now blocked buys of the volatile shares). With massive buys — and faith in GameStop investor Ryan Cohen — the group pushed the retailer’s stock to $159.18, a 145% increase, Business Insider reports.

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But on the other side of the fence sit GameStop short sellers, steadfast in their opinion that the company will ultimately fail and shares will drop. Bloomberg reports that 139% of GameStop stock was borrowed and sold short recently. Although the decision led to $6 billion in losses to date for the year, the short sellers continue coming on strong.

“If you’re short a stock right now, you’re really running serious risk to your portfolio to be in those stocks,” Stuart Kaiser, head of derivatives research at UBS Group AG told Bloomberg.

But what exactly is a short? And should you ever bet against high-profile stocks in the hopes of quick returns?

See: How the World’s Richest People Can Lose Billions in a Single DayFind: 11 Craziest Money-Losing Wall Street Moves in History

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What Is Short-Selling?

When traders decide to short a stock, they borrow a stock, sell that stock at market price, and then buy it back to return it to the seller. If the stock drops in price after they sell it, they can buy it back at a profit. When stocks plummet, short sellers find themselves on top. And because stocks tend to lose value faster than they rally, short selling can be a profitable strategy for day traders.

However, unlike buy-and-hold investors, who can just hold a stock until its value creeps up to their buy price or higher, short sellers risk losing a bundle short-term. Even if a company goes bankrupt, a stockholder can’t lose more than they originally invested. But a short-seller can lose limitless amounts because at some point, they must buy the stock back to return it to their lender. It’s a high-risk investment game, and the players often go to great lengths to devalue a stock and save their wallets. But sometimes, they encounter shareholders just as passionate about seeing the company succeed as the short seller is to see it fail.

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Betting Against Success?

Perhaps the most notorious team of short-sellers is $TSLAQ, a team of Tesla (NASDAQ: TSLA) short sellers who would do seemingly anything to see the electric vehicle manufacturer fail. The group spreads rumors and spotlights breakdowns of Tesla cars on Twitter to attempt to discredit the cars’ quality.

As Tesla skyrocketed in 2020 with a 700% jump and continued its climb in the new year, Tesla short sellers lost $1 billion on the second day of 2021 (the first day the stock market was open) alone. As the stock has risen to $880.80 today, up 151 points since the beginning of January, they’ve lost even more.

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See: “Don’t Sell a Share,” Says Billionaire Even as Tesla Stock DipsFind: Stocks Showing the Most Promise at the Start of 2021

Does Short Selling Ever Pay?

In the short term, short sellers could get lucky or spot a losing stock and make fast money. But in general, a positive outlook — in life and finance — will get you further. If there’s anything those studying the stock market can take away from retail investors and groups like WallStreetBets, it’s that, in the long term, it pays to support companies and people you believe in. GameStop and Tesla stand as prime examples of betting for entrepreneurs with strong ideas and a passion for their respective industries.

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This story has been updated to reflect the latest news about the Robinhood app’s attempts to shut down purchases of GameStop.


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