This article was originally produced as a video market update: https://www.youtube.com/watch?v=LXxS2qGjRtg&t=1s
Over the past month, there has been a lot of discussion in the media about dramatic price swings in the shares of companies like GameStop, Blackberry, AMC, and Bed Bath and Beyond. This has left many people asking questions about short-selling market manipulation and volatility and how this affects their Wealth Stewards portfolio. Now here's a quote from a website Investopedia. If you want to dig deeper, go to investopedia.com and search for short selling. In January 2021 short squeezes occurred on several different stocks, including GameStop and AMC entertainment holdings, Inc.
Following the efforts by retail traders on Reddit to drive up the price of these stocks. This resulted in large price swings. As short sellers were forced to cover their short positions for substantial losses. These volatile price movements were not driven by fundamental factors or news about these companies. Investors should be particularly cautious when considering trading stocks during short squeezes, short-selling occurs when an investor borrows a security and sells it on the open market planning to buy it back later for less money, short sellers bet on and profit from a drop in a securities price. This can be contrasted with long investors who always want the price to go up.
Short selling has a high risk high reward ratio. It can offer big profits. But losses can mount quickly and infinitely, due to margin calls for buyers of stocks, potential is unlimited and losses are limited to the value of the purchase. For short sellers, potential is limited to only the value of the stock, but risk is unlimited. A short squeeze happens when the price of the stock that is heavily shorted. Starts to rise and short sellers start to feel pressure as losses mount. This also triggers margin calls, forces, short sellers to buy back their position, which pushes the stock price even higher. If a thought is actively shorted with a high, short float and days to cover ratio, it is also a risk of experiencing a short squeeze.
A short squeeze happens when a stock begins to rise, and short sellers cover their trades by buying their short positions back. This buying can turn into a feedback loop. Demand for the shares, attracts more buyers, which pushes the stock even higher, causing more short sellers to buy back or cover their position. So let's take a closer look at GameStop. Since 2018 earnings of $4, a share shifted to a loss of over $10 a share his buying preferences for games changed from in-store to online purchases and short sellers viewed this as an opportunity to sell the shares at current levels. With the view that prices would drop as the losses mounted.
Internet investors joined forces in January and targeted a few of these firms that were heavily shorted, which forces prices higher, which resulted in short sellers buying. Which pushed the prices even further as the calendar year changed to 2021, there were 71.2 million shares shorted compared to 69.75 million shares outstanding so virtually every share outstanding had been shorted. Suddenly a large group of buyers driven by the organization of followers, of websites, like Reddit banded together and bought large volumes of shares, which naturally pushed prices of GameStop higher, which put pressure on short selling,through margin call. Prices rocketed higher and trading volumes rocketed as well.
But look at what has happened since the peak prices have plummeted from over $300 to $73 and may continue to decline to pre squeeze prices. Now, if we broaden our view, we can see the same, same thing happened to Game Stop, Blackberry, AMC,and Bed Bath and Beyond. And you can look at how sharply these stocks rose in price in a very, very, very short period of time only to tank to much lower levels. And all of this happened within a month. Although this seems like a get rich quick strategy. It all comes down to your trust in a stock promoters. If you've got in early and sold at the peak, not knowing where the peak is or was you did really well, but if you got in late, you got something handed to you and it wasn't a thank you card.
Those had gotten late suffered large losses, a very dangerous game. There was also a lot of talk about how a group of internet followers stuck it to the man. Short sellers are being depicted as bad people who take advantage of the average investor. Some fall into this category but many provide the average investor with lower risk strategies as they use shorting to offset the portfolio risk. At Wealth Stewards, we don't short stocks. We help people to invest wisely in good large companies with strong balance sheets and earnings growth. Not companies that are on the verge of bankruptcy. We're always concerned that this type of trading weakens investor confidence and can have negative short-term impacts on the prices of great companies, but these things happen in the markets.
And it's more important to keep an eye on your strategy and not let this type of news disrupt your long-term plan.