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Individual traders bid up stock prices in a war with hedge funds

Shares of Gamestop, AMC, and other weak companies have surged this week

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Photo (c) NicolasMcComber - Getty Images
It’s been a wild week on Wall Street, to say the least. Individual stock traders organizing in a forum on Reddit began buying shares of Gamestop, with the expressed purpose of financially damaging hedge fund traders who were shorting the stock.

They were so successful that by the end of the week, they had forced almost all the “shorts” to abandon their positions at huge losses. In the process, this $10 stock shot up to nearly $500 at one point.

The campaign against shorts, mostly hedge funds, quickly spread to shares of AMC, Blackberry, Koss, Bed Bath & Beyond, and American Airlines. What do these companies have in common?

There are all in declining industries. Their share prices have been falling for some time, which is the reason so many hedge funds and institutional investors are betting against the companies.

Organized buying

The strategy by the organized traders is simple. By encouraging thousands of traders to buy shares of these beaten-down companies, the stock price goes up. If it goes up enough, all the “shorts” will be forced to buy shares to cover their short positions, sending the price even higher.

The phenomenon has captured the public imagination this week, with many people wondering how they can profit from this too. But therein lies the danger.

“Being given the keys to a car is only good if someone knows what they’re doing when they sit behind the wheel, including understanding the risks and the need to have insurance and keeping a seat belt fastened,” Mark Hamrick, senior economic analyst at Bankrate.com, told ConsumerAffairs.

A look at the charts of these stocks tells the story. On Thursday, shares of Gamestop traded as high as $482 and as low as $112.25. Depending on where you purchased shares, you could make a killing or get crushed. Hamrick said traders need to ask themselves some questions before jumping into the deep end of the pool.

“Can you afford to lose all of the money?” he asked. “Chasing after high momentum stocks is only for those who have taken care of other basic financial needs first, including saving for emergencies and saving for retirement. Are all other key financial goals and needs being met? Our Bankrate surveys have traditionally found that the failure to save is the number-one financial regret.”

Hitting the brakes

By the end of the week, some online trading platforms, including Robinhood, restricted trading in Gamestop, AMC, and some of the other highly traded stocks. 

“We continuously monitor the markets and make changes where necessary. In light of recent volatility, we are restricting transactions for certain securities to position closing only, including $AAL, $AMC, $BB, $BBBY, $CTRM, $EXPR, $GME, $KOSS, $NAKD, $NOK, $SNDL, $TR, and $TRVG,” Robinhood said in a statement Thursday. “We also raised margin requirements for certain securities.”

The company later said it would allow some trading in these stocks, under certain circumstances, starting today.

Before the mania dies down, the Securities and Exchange (SEC) may wade into the controversy since it’s unclear how what’s been happening on social media differs from a classic “pump and dump” scheme, in which holders of a stock encourage others to buy it before selling at a profit.

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