It’s never a dull day on the internet, especially not in this age. This time around, microblogging and community platform Reddit is at the center of attention after a number of users put a multi-billion dent on Wallstreet in an attempt to teach hedge funds a lesson.
Before we get into the details, here are a few prerequisites to be aware of:
- A hedge fund is a partnership between multiple wealthy investors and a fund manager. The wealthy investors pool their money together and the fund manager then trades this pool of money in some high-risk investments with the aim of making some quick cash.
- Short selling is when investors make money by betting on a company’s shares to crash in price. For example, John borrows shares from Brian in company X and promises to give back the shares with a certain amount of money on top. John sells these shares at KES 100 and instantly makes 100 bob profit. Pays 10 bob to Brian for letting him borrow the shares and then hopes that the shares will crush to a lower price. In this case, let’s say KES 60, so that he can buy them back cheaper and then return them to Brian. In our example, John will have made 100 bob initially, spent 10 bob on Brian and a further 60 bob on buying back the shares, thus making a profit of 30 bob without spending his own money.
With that out of the way, let’s dive into Melvin Capital vs Reddit users and how the former’s plan to crash GameStop’s (a video game store) shares went out of control.
Where It All Started
Melvin Capital, a hedge fund had the brilliant idea to force GameStop’s shares into a nosedive, in a short-selling mission, which apparently is a common practice in Wallstreet. Melvin Capital’s plan was working as GameStop’s share price dropped from $20 to $4 within months. However, the hedge fund didn’t stop there and they kept coming after GameStop, month after month, making billions of dollars from short selling and almost pushing the video game store into bankruptcy.
This greed was captured by a group of Redditors who specialize in trading and investments under the subreddit, Wallstreetbets. The Redditors noted that GameStop’s shares had been forcefully dropped by 140%, way more than the shares available in the market. With this loophole, the guys at Wallstreetbets subreddit started a campaign that would eventually put Melvin Capital on the receiving end.
The Games Begin
Redditors started buying GameStop’s shares off the market. The plan was to drive the share price back up and make money when the hedge fund eventually has to buy back these shares in order to refund them to the lender. Remember, Melvin Capital sold GameStop’s shares at $20 and was buying them back at $4 which means they were making at least $16 per share until Reddit happened.
Due to the massive buying from random Reddit users, GameStop’s shares started to go up from $4 to $76 on Monday and eventually $147.98 as of 26th January. This means that Melvin Capital was now making a loss of $143.98 per share. Seeing this, the hedge fund tried to manipulate the stock again through massive selling, to bring the price down but instead, this attracted the attention of a group of people referred to as “whales”.
— Elon Musk (@elonmusk) January 26, 2021
These are multi-millionaire investors who have the ability to impact the stock market due to their high liquidity. Traditionally, Whales and hedge funds are not friends and this was an opportunity for payback. Led by the current richest man, Elon Musk, the whales bought GameStop’s shares pushing the price up further to $203 on 27th January.
Melvin Capital Cries Faul
Now facing bankruptcy, after being bailed out by a fellow hedge fund, Melvin Capital is crying foul and accusing the Redditors of manipulating the stock market, something that they themselves do, btw. The hedge funds have now come together to get the government’s attention in an effort to close trading on GameStop and mitigate their losses.
— Reuters (@Reuters) January 28, 2021
While it is not yet clear what exactly will happen, as it stands, Melvin Capital is technically bankrupt, and more hedge funds face the same fate. There’s potential for losses in Million on all parties involved, including the Redditors that started it all but as things are right now, the Redditors who have already cashed out are donating part of their profits to charity.