Why a Reddit group pumped GameStop shares up 1,000% on a lark

Shares in a U.S. retail chain that hasn't made any money in yearshave risen by 1,000 per cent inless than two weeks, wiping out billions of dollars from two Wall Street investment fundsin the process.

The sentence above makes little sense at first blush, but it is nonetheless an apt description of the saga currently underway surrounding shares in GameStop.

GameStop is a retail chain with about 5,000 locations across North America which, as its name suggests, sells video games and game-related accessories.

Like many retailers, its business has been under pressure for several years now, because ofa shift away from physical stores and toward online selling, which GameStop currently does very little of.Then the pandemic hit, exacerbated those problemsand sent the stock down to multi-year lows.

In the early days of COVID-19, the company's shares were changing hands at around $4US a share. They hit almost $400 on Wednesdayfor no good reason other than being caught in the middle of an epic battle between a couple of million onlineDavids who share stock tips on profanity-riddled message boardsand the bespoke-suited stuffyGoliaths of Wall Street investment funds.

Wall Street has been betting against GameStop shares for well over a year nowas investors known as short sellershave profited from the company's misery, driving the price down from around$25 in early 2017 toaround $5 for most of last year.

Unlike long-term stock owners, short sellers make money on falling shares by borrowing the shares from existing shareholders, selling themand then buying them back to replace the shares they borrowed at a lower price later and pocketing the difference.

WATCH: Here's an example of how short selling works using real numbers:

How short selling works

5 years ago

Duration 0:46

An animated explanation of how people make money from stocks losing value

As long as the price goes down, short sellers make money. But when the stock goes up, short sellers have to buy into a rising market, which adds to the buying pressure, which pushes prices up even more in a vicious cycle for the short. That's known as a short squeeze, and what we're seeing right now may be the most dramatic one in history.

EnterWallStreetBets

The short sellers' best-laid plans for GameStopstarted to go off the railsa few months ago, when some members of a prominent Reddit community called WallStreetBetssaw an opportunity to make some moneyand teach Wall Street a lesson in the process.

While many members of the subredditof DIY investorsgenuinely think GameStop's core business of selling video games is a promising one, a small number of them saw an added reason to buy in because they caught wind of agrowing short interest in the stock.

If enough buyers buy into a company and refuse to sell, the theory goes, that will drive the price of the shares higher. That, in turn, forces short sellers to fuel the price rise against their will by making them buy at ever-higher prices to cover their bets. The harder it is to find a stock to cover the short, the more expensive it will get, until momentum shifts.

The member credited with starting the movement, who goes by the handle Deep[Expletive]Value has posted screen grabsthat suggest he has managed to turn an initial investment of about $50,000into more than $20 million, simply by buying and holding.

Holding the shares away from shorts also increases the cost of borrowing for shorts, who at one point this week were being charged one-third of the price of the stock for the right to short it.At current prices, that means it would cost about $100 to short the stock, which means any profit would depend on the stock price falling by at least that much. Which it isn't doing.

Research firm S3 calculates that short sellers have lost $5 billion on GameStop so far this year. At least two have seen their stakes completely wiped out.

The Redditor cited abovedeclined an interview request with CBC News for this story, but he is far from the only one buying.

Alex Panayiis a regular contributor to the forum, and he says he saw a good investment case for the company months ago, based on their core business of selling video games. He took his firststake at around $30 and sold a bit at $55 but soon regretted it. Once he saw the momentum gathering, he added to his position again and again, even buying as high as $86 because, he said, the math added up. He could buy in relatively low into a business legitimately turning itself around, with the added bonus that he knew Wall Street had bet wrong and would have to buy in, too, to cover their bad bets.

"It's not the retail investors being greedy, it's ... the short sellers," he said in an interview.

At one point, short interest in the stock topped 140 per cent. That means short sellers were trying to short more shares of GameStop than there are in existence.

"That's greedy, and when that happens, they open themselves up for this huge risk," Panayi said.

LISTEN: CBC's Front Burner looked at the GamStop saga, and what it all means

Front Burner28:15The GameStop stock saga, explained

Winning one for the little guy

While he's enjoying the financial windfall of his savvy trade "I have plans for a down payment on a house," he said Panayi is one of many on the forum who are savouring the feeling that the little guy can get one over on the biggunsonce in a while.

The mainstream investment world treats retail investors "like we don't know what's best for us," he says, so they gate-keep informationand charge fees for bad advice and more fees to act on it.

But online communities on platforms such asReddit are letting people share their research for freewhilezero-commission brokerages such asRobinhoodaptly named after the English folk hero who robbed from the rich to give to the poor are shaking up the industry.

"I think this is a big scare to them because ... retail investors, we can make decisions for ourselves,"Panayi said.

"We have some leverage in this thing [because]they screwed up ... but that doesn't mean that the other side is like the devil or something."

Other targets

GameStopinvestors aren't the onlyonesbenefiting from the trend. A slew of previously moribund stocks have been on a tear of late, with tech companies such asBlackBerry(up 500 per cent since Christmas),movie chain AMC (up 300 per cent on Wednesday alone),U.S. retailer Bed Bath and Beyond (up 250 per cent since December) and even candy brand Tootsie Roll seeing outsized gains this week with the latter's shares up a sickly sweet 53 per cent on Wednesday alone.

The companies have little in common, savefor the fact thatmany have been shorted by Wall Street, and all have become the darling of retail investors eschewing the advice of the pros who get paid to pick winners and losers.

Dan Kent, the CEO of investment research portal StockTrades.ca, says he's noticed the trend.

While he says members of his online investor community are nowhere near as colourfuloradventurous whenit comes toriskas the Redditors, he has detected a similar trend afootas more new investors pile into rising names.

"This is definitely a rise of retail investors that are essentially sick and tired of these companiescoming out and short selling these stocks," he said in an interview.

His site has had250,000 views in the past week or so. That's more than twice as much traffic as it would have seen about a year ago. That also lines up with data that shows retail investors are making up about one-quarter of all stock trades right now. In 2019, they were barely 10 per cent.

German investment bank Deutsche Bank tabulated trading data in a report this week and found that retail traders are "largely responsible" for mosthigh-flying stocks right now.

"The bulk of the increase continues to be driven by very small contract sizes, reflecting retail buying," strategist Binky Chadhasaid in a recentinvestor note.

"In our view, increased retail participation is largely responsible for elevated equity multiples."

Most of that money is moving from large profitable firms and towardmore volatile names such asthe ones listed above, many with slim to no profitability, he said.

While Kent says he can sympathize with the desire to teach Wall Street short sellers anexpensive lesson, he worries about how this will end for small investors jumping in now.

"A lot of them don't know what they're doing," he said. "Eventually, the bottom will fall out ,and a lot of retail investors who got in too late are going to lose a fortune."