What is shorting a stock and what does that have to do with GameStop and Roaring Kitty?

GameStop has been in the news a lot this week, so let's chat about it!

Let's start by talking about what happened a couple of years ago with them. I remember this because I had their ticker projected in my accounting class while I was teaching, and the whole class became about stocks, which was so much more fun!

What exactly happened?

Okay, so what happened with GameStop stock? A young investing group on a Reddit forum decided to buy GameStop shares to stick it to the boomers on Wall Street (big-time investors). I'm picturing them sitting around chatting on the forum, and someone says they are tired of the stock market and that a bunch of baby boomers are telling them what to do.

Then another person who is also playing Deathloop says they are bummed about GameStop going down. An ex-financial analyst put the two thoughts together, and it was on! I can SO picture it!

If I loved GameStop, I would have been depressed too. I mean, have you ever been to, or even seen, a GameStop store lately? We have one in my town, and if it weren't next to a Jamba Juice, there wouldn't be any cars in the parking lot.

So, it's not a stellar investment, but this group of people was brilliant. They knew that the boomers on Wall Street had the stock shorted. The Wall Street guys were betting that GameStop stock would go down.  

So, what the heck is shorting a stock?

Imagine you're at an epic party, and you borrow your friend's ultra-expensive designer purse and tell her that you will return it later. You sneak out and sell the purse for $500 because you heard there's a sale coming up where you can buy the same purse for just $300. Cha-ching! Your plan is to pocket the $200 difference and return the purse to your friend. She will think you had it cleaned, and everyone will be happy!

But here's the catch—imagine Taylor Swift's new video shows her with that purse, and the price skyrockets because more people want it. Your friend remembers that you borrowed the purse and texts you wanting it back today. You go to buy the purse, and the price has gone up to $1,000 instead of dropping to $300. So, what you thought was going to be a $200 in your pocket costs you $500!

It's the same in the stock market world, except you borrow shares of stock rather than a purse.  Let's say you borrow 100 shares of stock. You have to pay a small fee to do this, but that's kind of like paying shipping on the purse. 

The stock price is currently $50 per share, so you sell the borrowed shares and have a cool $5,000 in your account. Woohoo! Now, you have to buy shares to give them back to the dude that you borrowed them from. You'll make more money the lower the price goes on the stock. This causes anxiety in me, but some folks get an adrenalin high from betting that the price of the stock goes down.

Now you wait, hoping the stock price drops a bunch, like waiting for that sale. If the stock price drops to $30 per share, it's like scoring that purse at Walmart. You then buy back the same number of shares you borrowed at the new lower price.

So, you buy back 100 shares at $30 each, spending only $3,000. You return the shares to the person you borrowed them from and make a cool $2,000! Another cha-ching! You're like the ultimate purse flipper but with stocks.

It's the same with the stock market.  The more people want a stock, the higher the price. Some guy named Roaring Kitty and his friends are buying up the stock, and the price skyrockets. Now, you have to buy the stock at, say, $125 per share to return the shares to the dude that you borrowed them from. So, you borrowed 100 shares of a $50 stock and got $5,000 in cash, but now you have to pay, say, $125 per share to pay the dude back! You only have $5,000, and you have to pay $12,500 to pay them back. Yikes!

That's exactly what happened, well, without Taylor Swift.

This is called a short squeeze. The Wall Street boomers who shorted GameStop had to buy back the shares at much higher prices to cover their positions, pushing the price even higher. It was like the designer purse suddenly becoming the hottest item ever, and you have to buy it back at an insane price to return it.

Short sellers of GameStop lost billions as the stock price skyrocketed from around $20 to nearly $500 in a matter of weeks. They stuck it to the man, and some people made a lot of money.  Roaring Kitty is now trying to replicate the movement with GameStop because he owns so much of it.  Maybe a little selfish at this point.

What's the key takeaway?

Shorting stocks can be a way to make money if you think a stock's price is going to drop, but it's a high-risk game. If things go differently than planned, you can avoid a financial mess.

So, while it's tempting to try and be the savvy trader who shorts stocks like a pro, remember it's not for the faint-hearted!  Remember what Rich Mom says – Never risk money you can't afford to lose, and don't invest with borrowed money.