Wall Street Outsiders versus the Hedge Funds
The investment world was convulsed last week when at least one hedge fund (Melvin Capital) lost billions of dollars. The sudden, massive losses happened when a tidal wave of independent individual investors, spearheaded by posts on Reddit.com, triggered a short squeeze that torpedoed the hedge fund.
For those of you unfamiliar with a “short squeeze,” let me explain. Most stock market investors “go long.” That means that they buy a stock and then hope to sell it later at a higher price. Short sellers do the same thing except in reverse sequence—that is, they sell first, hopefully at a high price—and then buy later, hopefully at a lower price. Whereas “long” investors make money when the price rises, short sellers make money when it falls.
A short squeeze happens when increased buying volume starts to push the price higher. Every dollar the price rises inflicts losses on short sellers. Because the only way to sell a stock short (that is, to sell a stock you don’t have) is to borrow it from a broker, the short seller not only pays interest on the borrowed shares, but as the price rises, he is legally required to transfer more money in his brokerage account to make sure that the lender doesn’t en
Article from Mises Wire