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Short squeeze Explained: Why Gamestop jumped 130%, AMC Entertainment shot up 300%

The unprecedented rally in these stocks is a result of an extraordinary frenzy among retail traders, as they organised on the message board site Reddit to push up the share price.

Written by Sandeep Singh , Edited by Explained Desk | New Delhi |
Updated: January 30, 2021 10:49:51 am
A shopper walks toward a GameStop Corp. store in Ottawa, Illinois, US. (Bloomberg Photo: Daniel Acker)

Even as the Dow Jones index fell sharply by over 2 per cent on Wednesday (January 27) after the United States Federal Reserve kept interest rates at near zero and pledged to continue to buy US treasury bonds worth $120 billion every month, shares of GameStop Corp jumped by over 130 per cent to close at $345, taking its market cap to $24 billion.

On January 12, the share of GameStop — an American video game and gaming merchandise retailer — closed at under $20 per share. In a matter of 10 trading sessions, the stock has jumped by over 15 times.

In a similar trend, the share price of the movie theatre chain AMC Entertainment jumped 300 per cent on Wednesday to close at $19.88, taking its market cap to $6.74 billion.

It was only on January 21 that the AMC stock had closed at $2.98 — it has now jumped by over 6 times in a matter of four trading sessions.

The unprecedented rally in these stocks is a result of an extraordinary frenzy among retail traders, as they organised on the message board site Reddit to push up the share price. And as the share prices jumped, it forced the short sellers in the stock to go for a ‘short squeeze’, leading to the staggering jump in share prices.

What is a short squeeze?

Short squeeze is a term used by market participants to refer to a phenomenon where short sellers in a stock who have placed their bets on a stock’s fall, rush to hedge their positions or buy the stock in the event of an adverse price movement, in order to cover their losses.

This leads to a sharp rise in demand for the share, and huge rally in share prices.

For example, if a trader expects that the price of stock X would fall to Rs 80 from Rs 100, she might take a short position in the stock to sell it at Rs 100, when actually the market price is much lower. However, if the stock price of the company starts rising, and jumps to Rs 120, the short seller starts incurring big losses — as she would have to sell the share at Rs 100 and deliver it after buying from the market at Rs 120.

In order to cover his loss, the trader who was initially short on the stock, starts buying the stock, which leads to a sharp rise in the share price of the stock. This phenomenon, where the short seller is buying the stock to cover her loss, is referred to as short squeeze in market parlance. It leads to a dramatic rise in share price, far beyond its fundamentals.

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Source: Bloomberg

How is this working now?

In developed markets, hedge funds and other investors have to disclose their short positions in any company, if it crosses a certain threshold. And as retail and other investors can find out such positions in the market, they can target a funds position by organising and buying that stock, and forcing the short seller to reverse her position.

In the current scenario, investors have organised on message board site Reddit to buy such stocks. Once the stock price starts to rise, the short sellers are forced to also buy the stock in order to hedge their position and cover their losses, leading to a huge surge in share prices.

Where is this happening?

Several stocks in the US, the UK, and other European markets are witnessing this phenomenon, and certain companies are seeing a staggering rise in their share prices.

Evotec SE, a Hamburg, Germany-based pharma company, saw its share price rise by up to 30 per cent intra day on Wednesday before retreating to close at $36.2, with a gain of 9.6 per cent.

British multinational publisher Pearson Inc. saw its share price jump 12 per cent for the same reason. Many other stocks across Europe are witnessing the phenomenon, which market participants say will force hedge funds to watch out for their short positions.

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