The financial tactic known as short-selling company shares was, until last week, one in which only stockbrokers took any interest.
But the battle over an obscure US retailer called GameStop between short-selling hedge funds and an online army has captured the imagination of millions, including young people.
Essentially, the battle was over a fair price for the shares of GameStop, whose main business is a network of 5000 video game stores in the US.
Some hedge funds – professional investment vehicles that use high-risk trading strategies and are often backed by superannuation funds – decided the struggling retailer’s prospects were bleak and its shares overvalued. They borrowed stock from other long-term holders for a fee, then sold the shares on the market to drive down the price with the hope of buying them back at a lower price for a profit. They would pocket the difference and then return the proceeds to their owners.
For reasons that remain obscure, a group of Quixotic nerds who frequent a forum on the website Reddit and use a trading app called RobinHood decided to defeat the hedge funds to prove a point; they started to buy GameStop shares en masse, pushing up the price.
As a result, the hedge funds lost their bet. They had to buy new shares at vastly inflated prices to give them back to the investors they had borrowed them from.
The crowd funders of GameStop are claiming a great victory against the short-sellers and the dark forces of capitalism.
Some left-wing theorists associated with the Occupy Wall Street movement of a few years ago say the practice of short-selling is disruptive because companies that are under attack by short-sellers often slash costs and staff to make themselves look more profitable and boost their share prices. Sometimes good companies can be taken over or even close, hurting existing shareholders.
There is also a mainstream debate about whether sharemarket rules such as those around borrowing shares favour short-seller hedge funds over existing shareholders. The Reddit crowd was outraged when, to protect the hedge funds against further rises in price of the shorted stock, trading in GameStop shares via Robinhood was closed down.
Whatever point they think they have made, the do-gooders who saved GameStop from the barbarian short-sellers are heading for a big fall themselves. So many people joined this crusade that the price of GameStop has now jumped 1000 per cent, a level unjustified by its fundamental business. It is almost inevitable the price of GameStop will fall to a tiny fraction of what most of the Robinhood appsters paid.
It is worrying that so many ordinary people are taking such an emotional attitude to the entrails of the financial markets. It has caused huge losses to many and worried regulators including Janet Yellen, the new US Secretary of the Treasury. But this popular anger against short-selling is misplaced. Short-selling can be a useful way to force poorly performing companies to improve. In some cases, short-sellers have played a key role in exposing serious corporate misconduct and fraud.
Ultimately companies’ best defence against short-sellers is to convince investors that they are doing a good job.
The deeper lesson about GameStop is the glimpse it provides into an obscure web-based subculture which preaches a deep distrust of capitalism.
It is perhaps not surprising that many people wonder about a system where the world is in deep recession but the sharemarket is trading at close to all-time highs. The crazy valuations on the sharemarket are certainly concerning but most people should exercise extreme care when investing their hard-earned. It is not a game for mugs or bleeding hearts.
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Source: Thanks smh.com