If you’re new to the WallStreetBets phenomenon, you should first take time to understand the concept of short selling. In a short sale, a trader sells an asset that they do not own. Specifically, an investor borrows an asset (e.g. shares in a particular stock) then agrees to buy it back on a specified later date and return it to the asset’s owner.
The expectation in a short sale is that the asset the investor is borrowing will drop in price. This means the investors can make a profit by selling their shares (which they don’t own) at a higher price and buying them back at the lower price.
Short selling is done on margin which makes it one of the riskiest forms of investing. That’s because the potential for loss is nearly unlimited. Nevertheless, hedge funds engage in the practice of short selling quite often. And that’s where WallStreetBets enters this discussion.
It has become the primary mission of WallStreetBets to “stick it to hedge funds” and they do this by creating what is known as a short squeeze. Here’s how that works. As we pointed out above, short sellers make money when they can sell stock at a higher price and buy it back at a lower price.
However, if the stock price starts to go up, short sellers will lose money. And if the stock continues to go up, the losses are potentially infinite. Plus, it can lead to other negative consequences. Fees can rise and/or the original investor (which can be another brokerage) will want their stock back. When this happens, the short sellers (i.e. “the shorts”) will have to cover their losses by buying the stock back at a high price. This of course is why certain stocks have gone “to the moon” in the words of the WallStreetBets crowd.