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Retail Investors Make Stock Market History

The week of January 25, 2021, saw a remarkable market event where retail investors bid up the price of a handful of stocks in an attempt to force a “short-squeeze” on major Wall Street hedge funds.  When an investor “shorts” a stock, which is a bet the stock is going to go down in price, the investor borrows the shares and then sells them at the existing price.  If the share price goes down, the investors will “cover” the short by buying at the lower price to return the borrowed shares, capturing the difference between what the investor sold the shares at and the cost to buy the shares back in order to return them.  Conversely, if the stock price goes up, the investor has to buy the shares at a high price than what the investor received when they were sold in order to return the borrowed share and loses the difference on the short play.

When shorting a stock, since the investor does not own the stock, the investor’s position is done on margin, that is, using credit from the brokerage firm.  As the value of the stock increases, the margin balance increases.  In such a situation, an investor can receive a “margin call”, where the brokerage firm forces the investor to close the position.  In a margin call from a short position, that means forcing the investor to buy the stock, regardless of the price, which is when there is this short-squeeze.

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