To earn big bucks, investment firms and hedge funds tend to follow a number of strategies, and one of the famous ones is short-selling. Usually it works for them, but sometimes — it does not.
For instance, one hedge fund lost a lot of money by short-selling an American retail video game company GameStop after its bid went horribly wrong.
Although the series of events took place over a year ago, they still hold relevance in the wake of recent charges levelled by short selling firm Hindenburg against the Adani Group.
This episode is eloquently portrayed in a famous Netflix series called ‘Eat the rich: The Game Stop saga’.
Besides the short-selling, the series also delineates fight between retail investors and Wall Street Bankers who tried to short-sell the stock of this video game company.
There are some media reports that suggest that people who bet against GameStop lost over $13 million.
The story is projected like a David Versus Goliath battle and underscores the power of retail investors. It shows how a small bunch of retail investors can also make a short seller face dirt.
How hedge funds follow short selling?
Hedge funds tend to maintain investment portfolio which are less subject to market swings and outperform the markets.
“It’s incredible difficult to beat the markets. So, the idea behind a hedge funds is that you will have an investment portfolio that is less subject to market swings. These hedge funds follow some strategies to do this. One of them is short selling. This, effectively, means a bet that the security is going to do down,” says Peter Sasaki, Chief Investment Officer, at Odeon Capital Advisors in the docuseries.
Short selling usually involves borrowing shares and selling them, expecting to buy them back later at a lower price before returning them to the lenders.
Thereby, they make profits on the difference between the higher sale price initially and the lower purchase price subsequently.
For instance, a short seller borrows an Infosys share from a stock owner for, say, ₹100, and buys it for a lower price, say ₹80 the next month to return it to the original owner. During this process, the short seller earns 20.
One big catch is that if the stock starts going up — the short seller can lose an infinite amount of money, and one can effectively lose far more money than the bet he had placed on it.
And this is exactly what had happened with GameStop, following which hedge fund Melvin Capital lost a huge amount of money.
