When the price falls, the short seller buys back the now cheaper stocks, returns them to the broker, and pocket the difference. But the strategy can be risky. When stocks go up – either because other investors make the opposite bet, as in the case of GameStop, or simply because the short seller did something wrong – short sellers lose.
Last year, when the stock market rose more than 16 percent, hedge funds, which were mostly short positions, lost nearly 47 percent, according to a hedge fund research index that tracks industry performance.
“Short sellers were beaten up in this bull market and left on the roadside for dead,” said James S. Chanos, founder of short-selling hedge fund Kynikos Associates, best known for predicting accounting fraud at Enron before it collapsed in 2001.
Mr Chanos, who made brief money with GameStop last week, said short sellers were once concerned about lawsuits from the companies they were targeting. But now they have to worry about social media attacks and, in some cases, personal safety.
Ms. Quadir, whose Safkhet Capital manages around $ 50 million, said it was especially challenging as a smaller hedge fund. “Try to be a fund manager dealing with organized crime, international money laundering and the Russian mafia while managing pocket money,” she said.
The GameStop trading craze showed the power of a new force: an army of retail investors powered by social media, driven by easy access to free trading apps, and eager to teach hedge funds a lesson. Hedge funds “left retail to hold the bag for YEARS,” posted a user on Reddit, suggesting that GameStop stock would go to the moon with a series of rocket emojis. “I see dead hedge funds,” wrote another.
Short sellers now have to worry about their financial viability. If millions of small investors band together to suddenly boost stock prices, the cost of selling short could soar to such an extent that short sellers find it unsustainable to stay in business. That almost happened to Melvin Capital, which took emergency money from other investors to improve itself.