The stock market is, largely, something that is much more boring in reality than it would seem to be. At least for those of us that aren’t day traders, playing with a massive bankroll in which small percentage swings result in massive gains and losses, the idea of “hitting it big” on the stock market is unlikely. We see movies of the chaos of wall street and big-phoned and even-bigger-tied traders that makes it feel like the stock market is a hot craps table. In reality, for most of us, the excitement of the stock market caps out at watching a well-regarded index fund slowly build a nest egg for retirement.

There are, of course, exceptions. Recently, a phenomenon has started to emerge that’s being referred to as “meme stocks”. GameStop and AMC began the phenomenon, and we’re currently in the midst of Bed Bath & Beyond’s enshrinement into the annals of meme stock history. For those only reading the headlines, it may seem completely out of nowhere, like Bed Bath and Beyond just announced the invention of the Towel 2.0 or something. In reality, these meme stock rallies are carefully calculated and built off of two things: collective buying power and short squeezes.

The origin of a meme stock requires a company that’s being shorted on a huge scale. If you don’t know what shorting is, here’s a quick explainer. Traditionally, we think of the stock market as betting on companies. I believe strongly in the future of Tootsie Rolls, so I’m going to buy Tootsie Roll stock, and the money I have invested in it will rise and fall in sync with Tootsie Roll at large. 

Pixabay

Tootsie roll, pictured at large.

Well, with betting on companies, people want a way to bet AGAINST them. That’s what shorting is. Instead of buying a stock for market price and sitting on it, shorting is effectively borrowing a stock and immediately selling it, with the promise that you will deliver X shares of that stock to the brokerage you borrowed it from in the future. Now, if you borrowed two shares of Tootsie Roll which you immediately sold for 50 bucks apiece, and then Tootsie Roll went absolutely ass up and the stock price later dropped to 25 dollars, when it came time to buy the 2 shares you owed, you could buy them for less than you originally sold them. It would cost 50 bucks to buy the shares you owed, a.k.a. “closing your short position,” and you’d be up a cool 50 bucks from the original sale. This is a SUCCESSFUL short.

Shorts are much less popular than traditional, or “long” trading, as they well should be, because of one other unique wrinkle. When you’re buying long, you can only lose as much money as you invest, since the lowest a stock can go is, well, zero. When you’re shorting stocks, however, you don’t have the safety of a mathematical floor of zero, since, in theory, there is no actual ceiling on how high any stock can go. This also means there is no actual cap on how much money you could potentially lose by shorting. If those 2 shares of Tootsie Roll you sold for 50 each are now trading at 1 million dollars a piece, (huge year for Tootsie Roll) you are on the line for 2 million dollars.

Pixabay

You, post the Tootsie Roll debacle.

Now, to finally loop back around to meme stocks: they happen when a group of people get together, lately mostly on Reddit, to find a stock that is massively shorted. They then all start buying up that stock in bulk, driving up the price. As we just covered, when that price starts going up, the people holding short positions are very quickly watching a debt on their books balloon. As that big red number grows bigger, it becomes a test of both faith and liquidity, which many start to fail as the stock price climbs. This forces them to close their position, paying the high prices for the stock they’ve promised to buy, which in turn, drives the price even higher. It basically results in an absolute frenzy to buy as much of that stock as possible, and that is how we end up with stocks like Bed Bath and Beyond more than doubling in value over a couple days.

Unfortunately, as with other meme stocks, by the time you’re reading this article, you’ve already missed out. But at least take some solace in the fact that a bunch of short position holders, who are usually massive smirking hedge funds, lost a whole bunch of money.

Top Image: Pixabay/Pixabay

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