How short-selling works, and why it didn't work on GameStop - Business Insider

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Here's how short-selling works, and how Reddit's day-trader army spoiled the strategy for GameStop bears

Millions of amateur traders on Reddit have pushed the price up.Short-sellers have taken a hit now that GameStop shares have topped $330, in what analysts have dubbed an irrational rallyWhen the market operates rationally, investors have the option to short a company's stock. In the case of GameStop, Melvin Capital and Citron Research were among the list of short sellers, and they've lost their bet, by a lot.

In shorting a stock, an investor borrows shares from a lender, let's say at $10 per share. The investor then takes the borrowed shares and sells them for that same price. Once the stock goes down, to let's say $1 per share, the investor buys the shares back and returns them to the lender, pocketing $9 per share.

"Let's say you short XYZ company at $100, and the next day it goes to $10. You take $10 out of your pocket and buy back the stock and give it to the guy you borrowed it from. And you have $90 in your pocket," Michael Pachter, an analyst at Wedbush, told Insider. Pachter added that there's the added cost of paying the interest on borrowing the stock, though if an investor only holds a short position for a month, the interest would be negligible.

But sometimes, like in the case of GameStop, the shorts get "squeezed" when the shares go up, said Telsey analyst Joe Feldman, who maintains the Street-high target price of $33 for GameStop. That means short sellers have to buy back the stock at a higher price. So if the shares were borrowed when the stock was $10, and now the stock is $20, the investor loses $10 per share.

 

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The only way this happens is when a short system gets out of control and where short interest exceeds the entire float of a stock. The fact that there were so many shorts created dilution that was intended to create selloffs and thus market losses. The squeeze turned the tables.

'When the market operates rationally...' You should have just stopped there. There is no rational market, just layers of speculation. That institutional speculators betting on the misfortune of others are getting boned by collective individuals doesn't concern me at all.

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