The meteoric rise of stocks like GameStop and AMC highlighted one of Wall Street's riskiest addictions: short selling. While a movement of retail investors helped spur GameStop's stock price despite a lack of solid fundamentals, hedge funds' position of roughly 121 percent of shares shorted at its peak played a key role as a rallying cry for those looking to counter a seemingly "risky" position. Data across 2020 shows just how much money is in play for top hedge funds looking to predict the decline of a company's stock price, especially those with the power to drive a stock price lower just by making the bet in the first place.
Short selling stocks is an inherently risky bet due to the nature of the transaction; by borrowing shares instead of buying them outright, investors could theoretically lose an incredibly large amount of money if the price skyrockets before they purchase them at an agreed-upon date. So why were there tens of billions of dollars invested in short positions in 2020 if the bets carry an added layer of risk for both retail investors and hedge funds? Ultimately, as shown by data collected from Yahoo Finance, investors lost much more money on short positions last year than they made, losing nearly $79 billion on the top 10 positions compared with profiting by less than $10 billion on the most successful positions. Investors looking to profit from the decline of companies like Tesla, Apple and Amazon in the wake of the COVID-19 pandemic were out of luck, while those who predicted the fall of Exxon, AT&T and Raytheon were rewarded.
The GameStop saga, whether it's over or not, showed how those placing the largest bets on short positions usually have an implicit influence on how those positions come to an end. The effect small retail investors have when compared to companies like BlackRock and Citadel seems to have been greatly overexaggerated by GameStop's late-January surge. BlackRock, with roughly $1.9 trillion in assets managed in 2020, and Citadel, with around $29 billion in assets managed last year, have great power in how stock prices behave just by taking large positions in the first place.
The volume of GameStop trades coupled with the short positions of major hedge funds over 2020 gave some small investors reasonable confidence that the stock was over-shorted and underpriced—leading to a growing price that began in the middle of 2020. The short positions persisted however, and a quick boom in small Reddit investors certainly caught many large hedge funds off guard. But many small investors falsely expected a continued surge in stock price even beyond the $400 high it reached—a surge that, as of now, has failed to materialize.
Overall, large hedge funds play a different stock market game than small retail investors. The restricting of trading to small investors—a restriction assumably absent from the trading between large hedge funds—lends itself to that point. Market movers like BlackRock and Citadel don't just create calculated short positions on companies they believe will decline; the size of the position itself ultimately plays a key role in how well the short position pays off.
