Freshly Squeezed

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What's going on?

GameStop and AMC Entertainment really got investors’ juices flowing this week, and it’s largely down to one thing: a “short squeeze”.

What does this mean?

First, the “short”: an investor can borrow shares from an owner for a fee and sell them on the stock market, hoping to profit by later buying them back at a lower price. That means they’re effectively betting against the stock.

Now for the “squeeze”. Other investors’ purchases of highly-shorted stocks drives their prices up, so short-sellers – who see their potential losses racking up – might then try to reverse their bet by buying the shares they’d initially sold. But if the sheer volume of buyers limits the supply of shares, short-sellers’ sudden demand for them will just push prices even higher – until they’re high enough to convince someone to sell. And since there’s no telling what price that’ll be, short-sellers’ losses are potentially infinite.

Why should I care?

For you personally: Easy come, easy go.

It can be wildly profitable to buy into the first throes of a short squeeze: early investors in GameStop, AMC, and BlackBerry have shown as much. But the positive momentum can turn on a dime, and you might be caught out if you’re a late-to-the-game buyer (tweet this). If, for instance, short-sellers do get their hands on enough shares to undo their bets, their desperate demand for shares will vanish as quickly as it appeared. And if no one else is willing to pay what they did, you might have to accept large losses when you sell up…

The bigger picture: The money has to come from somewhere.

If investors unexpectedly caught in a short squeeze need to repurchase their shorts, they might have to fire-sell some of their stocks to free up cash. And fresh data from Bloomberg this week suggests that’s exactly what happened: some of hedge funds’ most popular stocks saw their prices tumble, likely contributing to all this week’s volatility.

Originally posted as part of the Finimize daily email.

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