GameStop, Reddit, and Market Mania: What Happened?

Posted on 3-11-2021

This week, Craig Siminski, of CMS Retirement Income Planning, shares an article discussing the story behind the extreme volatility of “meme” stocks promoted through social media, including the risk for individual investors:

Over the course of 11 trading days in late January 2021, the stock of GameStop, a struggling brick-and-mortar video game retailer, skyrocketed by more than 2,200% — creating a mix of excitement and concern throughout the financial world.

Other stocks of small, struggling companies made similar though less dramatic moves.

At the heart of this story are two very different sets of investors: (1) professional managers of multibillion-dollar hedge funds, who took large, risky positions betting that GameStop stock would drop in price; and (2) a small army of individual investors, connected through social news aggregator Reddit and other social media sites, who worked together to buy large numbers of shares in order to drive the stock price up.

The opposing forces created a feeding frenzy that sent the stock to dizzying heights far beyond the fundamental value of the company. The price peaked on January 28 and lost almost 90% of its peak value over the next five trading days before leveling off.

Here are answers to some questions you may have about the market volatility triggered by “meme” stocks, an Internet term for stocks heavily promoted through social media:

What Were the Hedge Funds Doing?

A hedge fund is an investment company that uses pooled funds to take an aggressive approach in an effort to outperform the market. These funds are typically open to a limited number of accredited investors and may require a high minimum investment.

In this case, certain hedge funds borrowed shares of GameStop from a brokerage firm — called borrowing on margin — and sold the shares at the market price, with the expectation that the share price would drop significantly by the time they had to return the shares to the lender. The funds could then…

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Craig Siminski is a CERTIFIED FINANCIAL PLANNER™ professional, with more than 22 years of experience. His goal is to provide families, business owners, and their employees with assistance in building their financial freedom.

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