What is naked shorting:

Was speaking to a friend today and he asked me to explain naked shorting.

Here’s part of how we got into this upcoming market crash...

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Let me quickly explain how the stock market works.

On the stock market, a company issues shares of the company that people/investors can buy.

The only group that can issue shares is the company itself, not anyone else.

When a company lists shares, institutions, mutual funds, hedge funds, ETFs and other investment vehicles can buy shares of these companies on several stock exchanges.

Retail/individual investors can also buy shares of the company.

There are a fixed number of shares the company can create. Supply of shares is fixed.

What has happened is institutions and hedge funds have naked shorted a few companies.

What is a naked short?

First let’s discuss shorting a company.

You short a company if you think the stock is going to go down.

The logistics of how you do this are important.

For a hedge fund/institution to short a company, they need to borrow shares from these institutions who have bought shares of the company.

So if bank A buys one million shares of company B, they can lend those shares out to hedge fund C.

The institutions are happy to lend out shares because they make money on interest.

The problem becomes when an institution lends out shares, another institution/hedge fund lends those shares out again. This is how naked shorting works.

Essentially there are 2 shares for the same real share. 

Why do they do this?

Because they make so much money with this practice.

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What hedge funds did is naked short a bunch of companies like AMC and Gamestop.

They created shares that didn’t exist.

They created money out of thin air.

That is illegal.

The problem is the system is designed such that doing this practice is allowed. Why?

Because all that happens is a monetary fine.

Banks, hedge funds, market makers and institutions are happy to pay this fine because it’s only millions of dollars. The cases don’t get litigated in court for years, they pay law firms tons of money to delay the cases as long as possible and then usually settle for millions of dollars.

That’s it.

If you could make billions of dollars while only paying millions of dollars in fines years later when most people forget about what you’ve done, this practice is incentivized.

Wall Street is a dirty game.

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The problem for them was the Internet found out.

Keith Gill, aka DFV, saw a glitch in the system.

As a gamer, he was following the Gamestop stock at the beginning of Covid and saw the short interest was at 140%.

Think about that for a second.

If a company has a set amount of shares, how can more shares be shorted than exists in the market?

Because of naked shorting.

He told people on Reddit and people were convinced.

Ryan Cohen also saw an opportunity to turn Gamestop into the digital gaming Amazon. He has subsequently hired tons of former Amazon execs to build Gamestop into a digital behemoth with a massive amount of real estate all over the world. He’s likely going to turn their stores into E-sports venues, places where customers can hang out and chill. He’s going to create a community for people, while also revamping their website to make it the best place to buy/sell/stream games..

Michael Burry also saw that you could have bought the whole company at one point for 200M.

This company was doing billions of dollars in revenue at their stores pre-Covid. A few months after Covid started, you could own the whole company for 200M.

Then January 2021 happened and the world saw what happened when you had a mini short squeeze.

Wrote about it at the time – here. It went from a single digit stock to 497 at the peak in a few months. That is not normal.

Then institutions stopped allowing buying.

The price crashed back down so most people probably thought the whole situation was over. The media made the general public and the world believe this whole situation was just a blip.

What the public doesn’t realize is people didn’t sell.

They bought more.

The Internet coordinated millions of retail investors into buying the same thing to bleed hedge funds.

How?

Because shorts have to cover.

That’s how the market works.

They can delay it as long as possible but they eventually have to pay it back.

Now imagine millions of people around the world control the entire float.

They can just sit and wait for whatever price they want.

Now imagine there are more shares than exist.

Institutions and hedge funds have to buy all those back at whatever price the market sets.

In order to get the shares, they have to raise capital. How do they do this to maintain their margin accounts?

They sell their long shares. They get money from crypto. They sell assets.

They’re just trying to extend this as long as possible because their goal is never to cover.

Mark Cuban told Reddit how they operate during his AMA in January.

By never covering, they hope to create what’s called death spiral financing.

Essentially the institutions short the company into bankruptcy so they don’t have to pay capital gains tax and take the money/assets from the company.

People’s jobs are lost.

People’s livelihoods are destroyed.

Communities lose an economic engine.

People lose healthcare.

Meanwhile hedge funds make all the money just sitting there at their computer.

It’s gross.

The Internet found out about all of this and engaged a community of people online. The misfits. The gamers. The people who have never had anything good happen for them. The people who work every day and don’t feel like their going anywhere. It invigorated this community of people online from all different walks of life.

Now the whole market is going to suffer in what’s going to be the largest redistribution of wealth we’ve ever seen in the stock market.

Rich people are going to be pissed. Countries are going to be pissed. Governments are going to be pissed because markets will crash.

But good. The regular person deserves a win.

The Internet completely democratized information and this is what happens when you bring millions of people around the world into the same cause.

Very exciting days ahead. Hope you enjoy the ride.