What is a short squeeze?
A short squeeze happens when a stock sees a rapid increase in price even though investors had previously bet on its decline. Those who’d taken the negative position then have to buy back the stock at a higher price to prevent further losses.
Supply falls short of demand and the scramble to get a hold of stock only drives the price up more.
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Read MoreBackground on GameStop
In 2020, things were looking grim for GameStop, both on the stock market and with its physical business.
The brick-and-mortar retailer once held a significant chunk of the video game market, but due to the pandemic and competition from internet retailers, it had been on the decline in recent years.
GameStop’s grim prospects made it a target of short sellers — that is, investors who borrow stocks they predict are about to drop so that they can sell the shares and then rebuy them later at a lower price. Basically, shorting a $10 stock that eventually drops to $5 nets the short seller $5 per share, less borrowing costs.
Within a short amount of time, GameStop had become the most shorted stock in the world. The stage was set.
The GameStop squeeze
Now, the short was already happening to the GameStop stock before the Reddit folks stepped in. The squeeze refers to the role they took in it. Buying up all the call options put the squeeze on short sellers to buy more to cover themselves, and that just intensified the pressure.
Think of it like suddenly finding yourself in quicksand: The more you struggle, the deeper you sink.
And some big players really sunk. The manager of one hedge fund, Melvin Capital, told CNBC that its short bet on GameStop had been canceled out entirely, thanks to the squeeze.
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The Reddit short squeeze
Enter the Reddit community r/wallstreetbets, a raucous online investing forum full of ironic trading talk and elaborate memes of the type only Reddit could produce.
Along with posters on some other investing forums, the r/wallstreetbets folks, for reasons known only to themselves, started an impromptu crusade against the GameStop short sellers. By gobbling up piles of GME shares and “call” options — which gave them the right (but not the obligation) to buy the stock at a predetermined price — they propelled the hapless GameStop stock upward, surprising everyone in the process, especially the short sellers.
This is what people mean when they talk about the “short squeeze.”
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Skip the waitlistHow did the Redditors do it?
That’s the really interesting part here. They used the investing app Robinhood, which offers commission-free investing. With Robinhood, you can invest any amount of money to build a balanced portfolio in real time.
The app allows you to buy and trade stocks, options, exchange-traded funds (EFTs) and even cryptocurrencies. You can invest in whatever you’re into. Or whatever your Reddit community is rallying around at the moment.
So even though most people didn’t have the the resources of a hedge fund, these Redditors were able to leverage their collective buying power through Robinhood, giving the big and better-capitalized institutional players a run for their money.
Has a short squeeze happened before?
This isn’t entirely unprecedented. Since the GameStop short, Bed, Bath & Beyond and Nokia received some similar attention from Redditors.
But back in 2008, Volkswagen also became a favorite of short sellers until it saw a massive rise in price over a short period of time. By late October, the stock price doubled. While the stock price did eventually fall back, it took a few months to do so.
In fact, those who watch the market closely will tell you that stocks involved in short squeezes generally take a few months to fall back after these surges.
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What is GameStop stock priced at today?
At the time of writing, GameStop shares were $14.90.
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