Retail investors have hit hedge fund short sellers with billions in losses in just a matter of days, and more are on the way. Some commentators are now calling for SEC investigations or new government regulations, but retail investors have done nothing wrong, and the government should reject indignant calls to punish David for daring to take down Goliath.
GameStop ($GME) stock, a struggling brick-and-mortar retailer of new and used video games, was trading around $4 last summer. For most of today it’s been in the $300s. Now $AMC and others are making similar big jumps. So what gives?
If you listen to much of the coverage, you might think this is irrational exuberance or evidence of a bubble about to pop. And maybe it is those things, but what this framing leaves out is the role of savvy investors seizing an opportunity for big profits.
Large funds shorted over 100% of $GME. They all but bet on the company to go bankrupt, but once enough money flowed in they were forced to scramble to cover potentially unlimited losses. As prices rose, they were forced to buy shares to cover their shorts, driving prices up even further.
The hedge funds simply bet wrong, but regulatory scrutiny is coming and, along with it, the possibility that the government will succumb to Wall Street pressure to change the rules.
If there’s a lesson to be learned here it should be for funds to consider more closely their overexposure through excessive short positions. But some seem to think it’s the small retail investors who should be restricted going forward.
There’s nothing inherently wrong with shorting. It improves the market’s price discovery function. But a short position is a big risk, and it’s not the proper role of government or the market exchanges to protect participants from the consequences of losing a risky bet. Short squeezes are how the market self-regulates such behavior.
Any effort to clamp down on retail investors, such as by shutting down the forums they use to communicate or making it harder for them to participate in the market, must be adamantly opposed.
