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Is the Era of Short-Selling Stocks Coming to an End?

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Reddit forums and short-selling probably were not in most people’s vocabulary before this year.

The meteoric rise and fall of the GameStop (GME) stock price — fueled by institutional short-sellers and rabid Reddit posters on the r/wallstreetbets thread — shined a spotlight on the practice of shorting stocks and how a few individuals could amass an army to flip the table on “Wall Street insiders” and potentially pocket incredible returns.

A lot of ink has been spilled on GameStop’s recent roller-coaster ride. For the past five years, GME gradually fell in value from the high 20s to a low of $2.57 last April. Most analysts had written off the stock as it seemed clear that brick-and-mortar stores selling physical copies of video games in an era of downloads and quarantine was not a winning strategy. The low value of the stock seemed accurately priced, and so when the stock started to rise in the second half of last year, the number of short-sellers rose as well.

A Quick Primer on Short-Selling

To short-sell a stock, an investor — call him Dave — borrows shares from another client — say, Steve — and sells them. Dave and Steve have accounts at the same brokerage firm, which handles the stock borrowing. A short position appears in Dave’s account, and he is required to buy them back at some future point and return them to Steve. If he is lucky, the price at which he sold will be greater than the price when he buys back in, and he will pocket the difference.

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A key understanding of this practice is that Steve is never aware that his shares have been borrowed and sold. He still sees them in his account, and he can sell them at any time (upon which the brokerage firm has to find another client to borrow shares from). What makes this all possible is that both Dave and Steve have a margin feature on their accounts, and the margin agreement that they both signed allows their brokerage firm and other clients to borrow their securities.

Brokerage firm Charles Schwab, for example, has the following verbiage in its account agreement:

“You agree and acknowledge that Securities and Other Property held in your Margin Account, now or in the future, can be borrowed (either separately or together with the property of others) by us (acting as principal) or by others.”

More Shares Sold Than Actually Exist?

For a brief moment on Jan. 22, 140 percent of GameStop’s public float (all of the shares available for the public to trade) was sold short. This was such an exceptionally rare event that Forbes reported “short interest levels have only exceeded 100% of a company’s float 15 times in ten years.”

Should the short-selling of securities be banned by the SEC?

While it may seem impossible for more shares to be sold than exist, the nature of “fund borrowing” allows this to happen.

Taking the above scenario where Dave borrows shares from Steve to sell them, there is another party on the other side of that trade, because it was Donna who bought those shares from Dave, and they were deposited in her account — even though Steve still sees them in his account. But now a fourth person, Mary, wants to short-sell too, and so she borrows these same shares from Donna and sells them. In essence, Steve’s shares have been sold twice. All of the brokerage firms involved in the transfers and trades keep track of the activity to ensure that the shares get returned when they are repurchased, and they get to pocket margin fees in the process.

Two Sides of Greed

While most investors invest in the hopes that the market will rise, a smaller, seemingly more savvy set looks for opportunities in the other direction, and last year this second group set their sights on GME. The stock had been rebounding from a low after Chewy co-founder Ryan Cohen joined GameStop’s board with aims to reduce store counts and focus on the digital market, The Wall Street Journal reported.

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The shorts began to pounce upon the stock, predicting it would fall, with hedge funds such as Citron Research and Point72 leading the charge. As the number of short-sold shares began to rise and the percentage of the short float hit historic levels, a small yet vocal group on the Reddit forum r/wallstreetbets took note of this. They began buying up loads of shares, purchased long call options and told anyone who would listen to do the same.

The stock price began to move up. The battle was on.

Putting the ‘Squeeze’ to the Shorts

A classic yet colossal “short squeeze” erupted onto the scene. As the holders of the short positions saw the GameStop price rise, many were forced to close out their positions to cut their losses. They had to buy back the shares they had borrowed, which caused the price to rise even more, resulting in even more buy-ins. It was a positive feedback loop that fed upon itself until the vast majority of the short positions were forced to be closed, resulting in billions of dollars in losses.

After the dust cleared, the stock, which was trading in the low 40s on Jan. 21, hit a whopping $483 per share one week later. Many lucky Redditors who had gotten out near the top reportedly made millions in a few days.

Meanwhile, S3 Partners estimated the total loss for short sellers topped $5 billion, with Citron Research reporting a complete loss from their short position. Citron was in such dire straits that private funds Citadel and Point72 needed to throw a cash lifeline of nearly $3 billion, CNBC reported.

The Aftermath and Lessons Learned

Vox reporter Rebecca Jennings posted a tweet that went viral on Jan. 27.


If nothing else, the GameStop saga taught average Americans that the stock market remains the most accessible way to build wealth. Unlike starting a business or buying real estate, this era of zero-fee brokerage accounts and commission-free trades has allowed anyone with a dollar to gain exposure to the stock market.

Therefore, it is important to understand how the market works. But much like filing taxes, budgeting and general economics, America does a poor job teaching young people about investing.

To throw a small amount of money into a security and get a feel for how it trades is an invaluable education. So, even if those boyfriends threw away a few hundred dollars in a short position, they gained real-world experience that they could have never otherwise received.

For Citron Research, and one supposes hedge funds like it, the lesson they learned was, unfortunately, to not telegraph intentionality. Almost immediately after the GameStop debacle, they discontinued publishing their reports on shorted stocks.


While resources remain to monitor stocks with large short positions — such as finviz or highshortinterest — these are not only imperfect but often list stale data. They also don’t reveal what the reports like those of Citron Research provided: the direction short interest was headed.

Won’t Somebody Think of the Children?

It is easy to watch with glee from the sidelines as the rowdy and uncouth Davids took on the establishment Goliaths, who had long prospered from falling company fortunes and arguably are a weight on the overall health of the market. No innocents got hurt, right? The Goliaths had it coming, and the Davids knew the risks when they plunged in, after all.

Rarely reported is that innocent people were hurt in this adventure, as Forbes reported back in February.

“If you’re a taxpayer or a government worker depending upon a state pension fund for your retirement security, you may be alarmed to learn that nearly all state pensions engage in high-risk strategies, including shorting stocks like GameStop all the time,” it said.

It seems irresponsible to the extreme that local and state governments would allow the pensions of millions of hard-working Americans to be invested in such speculative hedge funds. One would hope that this lesson, above all, is the one learned the best — as all painful lessons are.

The Future of Short Selling

So, is the era of short-selling at its end?

A quick glance at highshortinterest reveals that short-selling is alive and well, albeit at much lower levels. However, the decision of major players to restrict the amount of information regarding their short selling also has the potential to limit their returns.

While GameStop showed the danger of disclosing large short positions when a small group of retail investors could rally together to drive the price up, disclosure, by nature, alerts other investors to consider shorting as well. Disclosing a large short position by a trusted fund with a proven track record inspires others, which only helps to further drive down the price and increase profits.

Reuters reported that Andrew Left, the head of Citron Research, indicated that he is adapting to this future.

“When we started Citron, it was to be against the establishment. But now we’ve actually become the establishment.”

This new reality reveals the careful line hedge funds have to walk now. They want to reach out and motivate investors to follow them in an investment play, while being careful to avoid alerting the Reddit rabble, who, having feasted well in January, seem to have developed a taste for blood and are hungry for their next meal.

This article appeared originally on The Western Journal.

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