29 Jan 2021

What's happening on Wall Street: An explainer

From Afternoons, 1:30 pm on 29 January 2021

Users of popular US platforms for trading stocks are in an uproar after a curb on buying shares in games firm GameStop and other companies.

It is the latest twist in a battle that has pitted amateur investors against Wall Street giants.

The Robinhood app used by day-traders and retail investors has banned trading on GameStop and other precarious retailers which hedge funds are currently attempting to short, meaning they are betting on their failure.

Shaan Puri, the co-host of the podcast My First Million and the fomer CEO of Bebo, joined Jesse to explain what it all means, and why he’s putting money into GameStop.

The exterior of the New York Stock Exchange is seen on November 4, 2020 in New York.

The exterior of the New York Stock Exchange is seen on November 4, 2020 in New York. Photo: Kena Betancur / AFP

He says there’s a battle between Main Street and Wall Street playing out in America.

“The reason this has caught everybody’s attention is because a small group of individual stock traders that were using Reddit started buying up a bunch of stock in GameStop and this caught my eye because I saw that some of these traders had turned $50,000 or $100,000 into more than $10 million in just a matter of months because GameStop’s stock had been going up and up this month.

“As I looked into it, I found a very interesting story underneath it which is that retail traders on this website basically bankrupted a multi-billion dollar hedge fund – that’s what caught my eye, I’ve never seen a hedge fund taken out overnight by a group of individual traders from a website.”

Puri says the reddit group, wallstreetbets, had noticed that the hedge fund had been overextended.

He explains: “They had been shorting a stock, which is basically betting a stock will go down, you borrow the shares now and you sell them because you think that later on they will be cheaper and you can buy it back at a cheaper price and return the borrowed shares, pocketing the difference.

“This hedge fund, essentially, had gotten a little bit greedy. They had shorted more shares than there even existed and, in that over extension, these traders noticed that if they started buying the stock, they could drive the price up while they are betting for it to go down.”

He says that, by using their greed against them, the reddit group was able to force hedge funds to have to buy the stock at a high price, which drove it even higher – called a ‘short squeeze’ in Wall Street lingo.

“They executed a short squeeze and, even if they’re 21-year-olds in their mother’s basements, they were very clever and profited greatly from it.”

That was the fun part of the story, Puri says, but now it’s turned ugly as stock trading platforms prevented GameStop and other retail stocks from being bought today.

“Many people are crying foul and saying it’s not right to stop people from being able to buy a stock just because these hedge funds are losing a lot of money.”

Puri says the group have acted within the law and everyone has the right to buy and sell stock and situations like this occur normally within the stock market.

“When an outsider gets wealthy off of it, I think that ruffled a few feathers in this case.”

He says short selling is a risky business and the hedge fund should have been more careful with taking on such an overextended position.

“They lost more than $2.5 billion in just a matter of days, they were almost put out of business and had to get a bailout from another hedge fund just to close out their position.”

With day traders now unable to buy more stock due to apps’ restrictions, the stock can only go down.

“That’s in the direction that the shorts wanted it to go.”

He says that trading on the stock should resume tomorrow and it will be interesting to see which direction it goes.

“Maybe the coordinated buying will have dissipated by then. We don’t know what will happen, it’s still an open book.”

Puri himself is in on the action, having invested $100,000 in stocks in GameStop, Bed Bath & Beyond and a couple other retailers.

“These were all businesses that people felt were dying, they weren’t the most exciting growth story stocks so that’s why they were targets for hedge funds to short.”

He says there’s no reason to feel sympathy for the hedge funds that are being squeezed.

“The founder of the hedge fund has a $45 million mansion in Miami… the rules of the game are set up so that the rich really do get richer. These are sophisticated investors; this is their job. They placed a trade that had a certain amount of risk and that risk played.”