How does the WallStreetBets community benefit from buying poorly performing stocks?

Question

According to

• Allison Morrow, Everything you need to know about how a Reddit group blew up GameStop's stock, CNN Business, January 28, 2021.

the subreddit r/wallstreetbets is buying, en masse, stocks that are being shorted by institutional investors. How does this benefit the members of r/wallstreetbets?

Once they decided to move onto another stock them all selling, at the same time, will mean they'll all stand to lose a lot of money, i.e., they won't be able to sell the shares for what they paid for them.

If it was a bunch of people with a high disposable income who were willing to throw away $100 / each to "stick it to the man", that'd be one thing as it's not monetary gain they're looking for, anyway. But if that's what it is then it seems to me that the problem will eventually self correct as the /r/wallstreetbets/ community eventually runs out of money?

Answer 1

The idea is that WSB members will buy up a bunch of the stock, which will raise the price of the stock. Short sellers will then buy up stock to cover their positions, and they'll have to buy those shares at the higher price. This will raise the price even more, then WSB members will sell their stock at this higher price. This sell off will then create a crash. If it goes as planned, there will be a net transfer of money from short sellers to WSB members. But this money will not be evenly distributed; those who bought in early and sold right before the crash will make the most, while those who bought later, or sold after the crash, will make less, or even lose money.

Basically, this is very much like a pyramid scheme, except that with a normal pyramid scheme, there is no outside source of money, so once the transaction costs are included, there's a net loss of money over all the participants. With WSB, on the other hand, the idea is to force short sellers to be the bottom of the pyramid, so that it's possible for the rest of the pyramid to make a net profit. With short-selling, you're essentially selling the stock before you're buying it. Or, in terms of a pyramid scheme, short sellers are cashing out of the pyramid scheme first, and then are forced later to buy into the scheme.

Imagine it's 2007 and you're trying to decide whether to invest in Bernie Madoff's "investment fund". You know it's a Ponzi scheme, but you also know that there are a bunch of people that have promised to "invest" money into the scheme. So you decide to put your money in, figuring that as long as Madoff has money from those other investors coming in, he'll keep running the fund. That's sort of what this is like, except not as illegal (probably).

Answer 2

how does this benefit the members of the /r/wallstreetbets/ ?

To simplify:

1. Institutional investors short stock A
2. Massive purchase from WSB of stock A
3. WSB members (on average) profit during the subsequent short squeeze.

Answer 3

From what I understood about the news coverage regarding this, was that the WallstreetBet community was not only/primarily interested in gaining money from this scheme but also/rather inflicting loss on the hedge funds who shorted GameStop. So apart from possible monetary gains, the WallstreetBet community gets the psychologically reward of teaching big finance a lesson. Or at least that's what they are pretending.

Answer 4

The biggest piece of information to understand is this: the number of shares short-sold actually exceeds the number of stocks in existence!

Gamestop wasn't chosen at random by the WSB folks - it had the record of the most shorted stock, at about 140% (a crazy high number).

All those short-sold stocks? They have to have their position closed at some point - which means that the person has to actually buy a share of the stock. And they might not have a choice - they have a debt of a stock, and if the value of that debt gets too large, the broker might force them to cut their losses (and buy the stock at that point in time.)

So the main two questions are this:

• When are the WSB folks going to sell their shares?
• When are the Hedge Fundies going to actually close out their positions?

The first one is very difficult to answer. The closest approximation I can give is of a Labor Strike. If a decent fraction of them cave and start selling, it could start a downward spiral (nobody wants to be the last one holding the bag.) Which is why the WSB folks are trying to keep unified together on it.

The second one is tough, because the fundies want to say, "This is just temporary; we'll wait until this blows over and then buy" when it's like $10/share." But they might not be given a choice, if the broker forces their hand to stop catastrophic losses. And if that happens? Well, there's another "nobody wants to be the last one holding the bag." Because 140% of shares need to be purchased at some point, and nobody wants to be the person forced out of a position buying stock for $10k+ per share.

Or another way to look at it is this: Gamestop's stock dropped from $30 to $3 in the span of 3 years (mid 2016 to mid 2019). This wasn't because the valuation got cut by 90%. It's because more and more hedge funds were shorting the stock (again, more shares were shorted than actually existed!) So you had a situation where the a potentially undervalued stock was only selling for $3 (because hedge fundies were flooding the market with additional shorted shares) and whose price might climb quite a bit as those hedge funds closed their positions. So people started buying the stock, even when it climbed to the pre-2016 levels. Not because they thought the company was necessarily worth that much - but because they knew there were an awful lot of shares that were going to be forced-purchased and it could cause a spike in price.

Answer 5

I find it hard to understand your question - it's rather disjointed, in particular it's not possible to run out of money as long as you don't put in new money. The folks on WSB bought the stock (or bought call options). As long as they don't buy more, they are not putting in new money, so they cannot run out of money.

Once they decided to move onto another stock them all selling, at the same time, will mean they'll all stand to lose a lot of money, i.e., they won't be able to sell the shares for what they paid for them.

Once they decide to move on (or take profits) and sell, then yes, the bubble will crash, GME will drop down to Earth, and whoever still holds the stock will lose a lot of money (in finance jargon this is known as "holding the bag"). So it becomes a mind game. If you sell now, you might lose out on making even more money if the short squeeze continues and the stock keep going up. On the other hand, if you don't sell now, the stock might crash tomorrow and you will be caught holding the bag. You want to sell just before the other people on WSB decide to sell, which is not something that is easily predictable.

But if that's what it is then it seems to me that the problem will eventually self correct ... ?

It really depends on what you consider the "problem", because for many people, there is no problem at all. Sure GME can gallop up and down, but if you're not invested in the stock, it doesn't affect you in the slightest.

Still, one thing we can say is that almost surely, GME will crash at some point. So "self-correct" is odds on to happen at some point. When that will happen, however, is something nobody knows.

Answer 6

The point here is that the community as a whole is not going to make money, any more than say Bernie Madoff's (https://en.wikipedia.org/wiki/Bernie_Madoff ) investors made money. Those few who thought up the scheme and got it started, and who bought stock at the original price, will benefit if they sell the shares they hold before the bubble bursts. Those who are left holding shares that they bought at higher prices than the eventual final price will lose most of their investment.

Just a new form of the old stock kiting/pump & dump scam, IMHO.

PS: From recent news articles, it now seems that the people who really benefitted from this (perhaps entirely by accident) are the GameStop management & board, and other investors with large holdings, who were able to dump their shares in a failing company at greatly exaggerated prices: https://www.marketwatch.com/story/gamestop-shareholder-sells-off-stake-valued-at-over-1-billion-11611855951