Over the past week, you’ve probably seen news report about GameStop. Many of our clients have had questions about what the saga is all about. Why are people in the financial market outraged and losing money?
It starts with a trading technique shorting stock, also known as short selling. This is where an investor borrows stock that they expect to fall and immediately sell it, in the hope that once the stock has fallen, they will buy it back and repay the lender of the stock the exact number of shares borrowed.
For example, say you believe the stock price of Telstra is overvalued and is going to crash soon, so you “borrow” a stock at $1.00 and sell straight away for $1.00. As the stock price falls you then rebuy the stock at $0.50 and repay the borrowing. As you already sold the original stock for $1.00, you’ve just made $0.50 profit on the falling stock. This is going short. Click here to see a short video on how it works.
Shorting stock has long been a popular way of trading for speculators, gamblers, hedge fund managers and individual investors willing to take on the risk of capital loss for potentially high financial reward.
So, what happened with GameStop?
Short sellers were caught off guard when the Reddit forum r/wallstreetbets lit the fuse that sent shares of GameStop Corp GME.N rocketing higher without a clear business reason. Instead of falling, the stock went up 1,900% and the “shorts” still needed to be repaid. This means the hedge funds instead of buying at a lower price are having to buy at a price 1,900% higher than anticipated. The GameStop share price 6 months ago was $4.15USD and the peak so far this month reached $347.51USD. Turning GameStop into another classic example of how short selling can leave you exposed to potentially large financial risk.
Short sellers were caught off guard when the Reddit forum r/wallstreetbets lit the fuse that sent shares of GameStop Corp GME.N rocketing higher without a clear business reason. Instead of falling, the stock went up 1,900% and the “shorts” still needed to be repaid. This means the hedge funds instead of buying at a lower price are having to buy at a price 1,900% higher than anticipated. The GameStop share price 6 months ago was $4.15USD and the peak so far this month reached $347.51USD. Turning GameStop into another classic example of how short selling can leave you exposed to potentially large financial risk.
The bottom line is to be aware of risk. You can’t – and shouldn’t – avoid risk altogether. By investing in assets with a level of risk you’re comfortable with, and spreading your money across several different types of investments, it is possible to manage risk and make it work in your favour to grow wealth.
If you’re keen to learn more about investing, we’d be happy to chat with you through the different ways you can start!
