In February, amateur investors experienced the volatility of the stock market firsthand. Spurred by social media, many bought shares of a few select companies. Their actions drove low value stocks high, shocking market veterans. Some insiders say such activity by amateurs should be illegal. But could those power players be sore losers?
In simple terms, the stock market is a system of buying and selling stocks, or shares of ownership in a company. Companies sell stocks to raise money for growing their businesses. People buy stocks as investments or simply to earn cash.
Stock prices rise and fall all day, every day, Monday through Friday. For long-term success, buyers hold stock, sometimes for years. They wait for the stocks to increase in value. Investors make money by selling stocks at a higher price than they paid.
However, professional stockholders have figured out how to profit from stocks they think will lose value. The strategy is called “short selling.”
Here’s how it works:
- An investor borrows (as in a loan from a bank) shares from a lender and promises to return them by a contracted date.
- The investor sells the borrowed stock right away. That’s because he or she expects the stock price to fall.
- If the prices do fall, the investor buys the shares back—for less than the selling price.
- The investor returns the borrowed shares and keeps the difference between the two sales.
Short selling can work . . . but only if the stock price declines as predicted. And that’s where trouble can happen. If prices rise instead, the investor must still buy the shares back to return. The more the stock price rises, the more money investors lose.
This winter, many large investors predicted falling prices for several companies such as AMC (American Multi-Cinema) and GameStop. Big-time investors planned to reap huge profits by short selling those stocks.
But a group of amateur investors outwitted the experts. The amateurs noticed the experts buying up AMC, GameStop, and others. They joined forces and purchased lots of shares themselves—at low prices. Social media channels buzzed with appeals to buy more. Prices for those stocks—especially GameStop—soared.
The professionals couldn’t buy the stocks back at a lower price. But they still needed to pay the lenders back. Eventually, the investors had to buy back at much higher prices. Many investment companies lost billions of dollars.
The frantic stock market venture appeared to end quickly. Within days, it was mostly game over for GameStop shares—though the stock saw a few late-game surges. Some new investors quickly made and lost small fortunes. But for many, the goal was to see big investors panic—and to beat them at their own game.
Do not rejoice when your enemy falls, and let not your heart be glad when he stumbles. — Proverbs 24:17
