Most men in suits on Wall Street have money and it isn’t all accumulated by buying stocks and going "long." Instead, some look for stocks that are oversold, inflated, or maybe have some bad news behind it (commonly a lawsuit) and exploit it to their benefit by shorting the stock and forcing the price to drop. Oftentimes before the short attack occurs, the Hedge Fund (HF from here on) will “pump” the stock to get the price to inflate even more: The higher the price, the more profitable the fall. Gamestop was shorted so heavily, some HF’s had naked shorts.
What is a naked short? Example: HF goes to a broker and borrows XYZ stock at $50 and then sells to retail buyer “Clueless A.” HF then has his Journalist buddies write a negative report on stock XYZ. XYZ then drops to $25 per share. HF buys back the stock from Clueless A (who has sold it at a loss of $25) and sells it back to the person he borrowed it from for $50, making $25 profit PER SHARE borrowed. Since HF never really owned the stocks to begin with, the funds go in to a margin account. The margin account must have 150% of the stocks value in it at all times. If not, HF gets a margin call.
Why do I name my character “Clueless?” Because HF borrowed shares from a broker. That broker may have used shares YOU own, but you will never know they were borrowed. HF borrowing funds to short affects the person borrowed from by manipulating the price so it drops. Clueless has unknowingly played a part in his own financial loss. The only way to circumvent this is to put a limit sell on your transactions at a highly inflated price. In the event of GME, lets put the price at $1000 per share.
Naked shorting is when HF borrows shares of a stock that literally do not exist. The practice is illegal but some do it anyway. If stock XYZ has 10,000 shares to short but HF is feeling super confident that the price is going to plummet, He may “borrow” shares in excess of the shortable amount (only on paper.) Example: XYZ has 10,000 shortable shares. There are 6,000 shares already shorted. HF feels this is easy money so he borrows the remaining 4,000 shares but sells 8,000 (4,000 actual and 4,000 on paper) to “Clueless B.”
In the case of GME, Clueless A and B won. How? Well, when the price of GME went up, HF had to cover shares he borrowed but at an INCREASED price- and 4,000 of those shares didn’t even exist! So, what does HF need to do? He has to cover at a HIGHLY inflated price- probably out of his pocket and “replace” shares he “borrowed” that never were there to begin with. Clueless now has HF by the balls so to speak because Clueless has shares but he aint letting go for anything under his sell limit of $1000 a share. Shorting is literally making a financial transaction with “money” that doesn’t exist. It is bad practice for many reasons and extremely risky.
However, if we consider the case of GME as a large momentum of retail investors who were able to increase the price by buying many shares of a highly shorted stock- enough to trigger a squeeze, as only a profit making venture, we would be short sighting ourselves. There is more to it. Retail investors have historically been targets of unscrupulous HF’s who artificially inflate stocks by “pumping” them with the goal of getting a lot of money on board from retail investors. But HF’s goal isn’t to make money going long. HF then puts out lots of negative publicity about the same stock creating fear and doubt among the retails, who sell out causing a drop in price. The retails lose and HF makes money because he shorted the stock on the way down. As I mentioned earlier, GME was heavily shorted, including the illegal practice of naked shorts. Retails are tired of losing money unfairly with what is known as pump and dumps. In fact, the stock market has been described as the “transfer of money from the retail sector to the wealthy.” And it happens over and over again.
Wall Street is money and money buys laws on the books. Don’t put it past them to change the rules in the middle of the game to benefit their practices even more so. They are already at an advantage. What we need is fairness. I was pretty impressed to see John Q. Public stick it to Wall Street. But I don’t think Wall Street is going to forget.
