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Joe Thompson's avatar

Loved the write up today, Isaac. As a right-leaning individual, I can't believe I'm totally aligned with AOC. She's right and I hope these folks have a reckoning. I bought $500 worth of AMC yesterday and had my two brother-in-laws do that same - we were so excited this morning only to watch Robinhood (of all platforms) prevent the purchase of AMC shares. The hypocrisy of that is sickening. To act like a hedge fund doesn't participate in "low analysis, momentum" investing is laughable on its face. I actually think this is only gonna further ignite the Reddit mob. We will see what happens. Thanks again.

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Shawn Spilman's avatar

Background: On any stock trade, you can be long or short.

If long, you give money and get stock. Should you not have the money, you must borrow it. Brokers will loan that money to you at their margin interest rate.

If short, you give stock and get money. Should you not have that stock, you must borrow it. Brokers who hold other peoples' stock will loan their shares to you for a fee. (Unless those people specifically tell them not to.)

Hedge funds: Being long is the safest bet. Why? Because, over time, markets always go up. Being short is typically a brief hedge, to protect against interim decline, and hence the name.

The total number of shares available is called the float. The total number that are shorted is the short interest. The collateral (either cash or stocks) that you put up when borrowing from a broker is called margin.

What happened: Sometimes hedge funds will sell shares they do not have without borrowing shares to deliver, even though this is illegal. People noticed, recently, that the short interest in Gamestop exceeded the float. More shares were sold than existed. Someone, likely Melvin among others, was selling shares they did not have without borrowing shares to deliver.

What happened next is classic tipping point. A few canny amateurs bought just enough shares to raise the price a little. It did not take much at $8 a share. The hedge funds got margin calls saying they needed to either put up more collateral or find shares to deliver. Some bought shares, which drove up the price a little more, and then this cycle just kept repeating.

It was not the amateurs who kept bidding shares higher. It was the shorts, closing out their position so they would not have to put up more margin cash. The amateurs just held on for the ride. Thus, there was no true price manipulation. A short squeeze feeds on itself. This happened to VW a decade ago and to TSLA last year.

When the short interest exceeds the float, a squeeze is inevitable because more shares were sold than there are shares to deliver. Unless the company goes broke and the share price falls to zero. Then, the shorts never have to cover. This is why short sellers, typically hedge funds, will try to hammer a company into the ground.

It is stupid to pay $300 for a share of Gamestop. Unless, of course, you are short and have no choice. (Melvin did not buy shares to cover; they put up more cash instead.) I am now speculating: It could be that the amateurs did not even have to buy shares at the start. Perhaps they merely withdrew permission for brokers to loan out shares they already owned. That, alone, could start a self-perpetuating short squeeze. Either way, it was the hedge funds, themselves, that drove up the price as they bid against one another to cover their massive shorts.

My Take: There are a few good places to trade stocks with zero commission. Robinhood is not one of them. Google "front running" to see why. (Vanguard is best, IMO, although their trading platform is flakey.) And never forget that you are not trading against other amateurs, nor even seasoned pros. You are trading against omniscient bots. Yes, it can be fun, just as casinos and lotteries are fun. And someone, somewhere, will even make a profit. But, in the long run, it almost certainly will not be you. Truly, VT is the only thing you need to own.

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