Securities Fraud Lawyers Blog
With the recent rise of meme stocks– both in the market and in the media – there has been plenty of talk about short squeezes and their impact. While short squeezes themselves are not a new concept, the unique market characteristics of 2021 have ushered them into the mainstream. Given the current market landscape, a sound understanding of short squeezes is critical in making informed investment decisions.
The COVID-19 pandemic lockdowns resulted in working from home and the distribution of stimulus checks, which when mixed with Reddit as a communications platform for retail investors, helped to fuel the meme stock phenomenon. A meme stock the term being used to describe any publicly traded company whose popularity stems from the use of social media platforms which draw everyday investors to purchase shares. [1] Classic examples from this year include GameStop and AMC, both of which have showed tremendous and at times ludicrous growth fueled by retail investors.
A short squeeze occurs when a stock’s price is rapidly driven up not because of any fundamental addition of value, but instead because of an excess of short selling. A short sale occurs when an investor makes an investment betting that the price of a stock will fall. This can take many forms, but commonly occurs when an institutional investor like a hedge fund believes a stock is overvalued and will soon fall, allowing them to turn a profit. The hedge fund will sell stock it ‘borrowed’ hoping that when they have to deliver the stock, its price will have fallen and they can purchase the stock that they have to deliver at a lower price.
When other investors, like retail investors on Reddit or other social media, realize a stock is being heavily shorted, they begin buying up the stock as well. As a result, the stock price increases in line with the laws of supply and demand, rather than decreasing as the investors with short positions had hoped. This triggers the short squeeze, and results in short sellers being forced to resolve their positions at potentially huge losses. In the case of GameStop, short sellers lost almost $2 billion collectively over a two-day span in February 2021 as a result of a short squeeze.
Recently, AMC Entertainment, another meme stock, has also shown strong short interest, and its price has skyrocketed. At the height of the COVID-19 pandemic, AMC’s ability to keep its theater doors open had faltered, making it a target for short sellers. However, retail investors began showing interest as the price increased from $2 in early January 2021 to $20 by the end of the month.
Since then, the price had hovered at around $10 until late May as COVID vaccinations led to loosening restrictions across the United States. Between May 4, 2021, and June 4, 2021, AMC’s stock price was up a massive 410% to $47.91, in part because of easing COVID restrictions, and also in part because of promises made by AMC’s CEO to shareholders. [2]
While AMC’s meteoric rise feels based at least partially in fact, since the company is indeed adding more value to the market now, with eased COVID restrictions, than they could have back in early 2021 at the height of the pandemic, experts still believe the stock is overvalued as no real changes have been made to their financials just yet. [3]
Whether or not a short squeeze ensues, its important to understand the actual value behind an investment before making any investment decisions. While shorting stocks may appear exciting, especially when get-rich-quick stories are echoed over social media, the most sound investments often take time.
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