Igor Joksović • feb 05, 2021
Short-selling stocks: a duel of amateurs and hedge funds on Wall Street
In recent weeks, we have witnessed an interesting event taking place in the most famous securities market – Wall Street, whose main protagonists are, on the one hand, amateurs in stock exchange trading, and on the other hand “hedge” funds and their owners. Skirmish trigger was a short-sellingstocks by GameStop Corp. which sells video games, electronics and other types of IT equipment.
In short, short-sellingis the lending of shares for a fixed period and their sale on the open market in the hope that their value will fall in the future, in order to make a profit by subsequently buying shares at a lower price. This type of stocks trading works according to the following model: the investor (usually hedge funds) borrows shares from the company’s shareholder for a limited period of time. At the time of borrowing, the value of the stocks is e.g. USD 100. The investor then sells the same stocks for USD 100. After a while, the value of the company’s stocks begins to decline, so that at one point it is only worth USD 20. In the meantime, the investor who borrowed the stocks has a deadline for returning the stocks to the shareholder since he borrowed them. As previously explained, a shareholder has sold the borrowed stocks, and therefore must purchase stocks from other shareholders in order to return them to the original shareholder. Since the value of the stocks fell, the investor buys the stocks but now at a price of USD 20, so investor is in plus of USD 80 because he sold the borrowed stocks for USD 100 but then bought it for USD 20 to return it to the shareholder since he borrowed.
In addition, it is necessary to point out that “shorting” is done when investors have insider information from the company that the value of stocks will begin to decline due to certain business problems. Also, it often happens that even the investors themselves create such an atmosphere by undertaking activities that cause the value of the stocks of a certain company to begin to decline (e.g. the spread of negative rumors about the future of the company). An excellent example of the functioning of “shorting” and artificially challenging the devaluation of the company’s stocks is described in the series “Billions”, in which the main character Bobby Axelrod, the owner of the hedge fund, is currently engaged in “shorting”.
Related to the event with GameStop Corp. stocks have jumped over 1000% since the beginning of 2021, thanks to individual amateur investors (there are about five million investors) who gathered on the WallStreetBets forum, posted on Reddit, began to buy shares from the revolt against hedge fund managers who bet their value would fall. The rapid growth of stocks has led to the fact that some hedge funds are at a loss of over five billion dollars, given that the funds now have to buy stocks at much higher prices than they sold in order to return the stocks to the shareholders from whom they borrowed. The current situation has prompted many across the U.S. to take revenge on the untouchable Wall Street jet set, by coordinating nearly five million WallStreetBets users, using an app like Robinhood that allows anyone to trade for a small or zero commission.
The current situation has prompted many across the U.S. to take revenge on the untouchable Wall Street jet set, by coordinating nearly five million WallStreetBets users, using an app like Robinhood that allows anyone to trade for a small or zero commission.
The question is whether the SEC – US Securities and Exchange Commission will intervene by taking measures to balance the changes in the stock market or will it remain a silent observer and let the market law work on its own, which according to experts could be unpredictable consequences.