Is Gamestop mulling a bid for GAME, or are short sellers just running scared?

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Yesterday, GAME Group shares jumped 15.5%, apparently sparked by a rumour that Gamestop was considering a bid.

I have no information or opinion on whether or not that bid is imminent or likely. I am more interested in the reasons that the Financial Times gave for the Game Group share price rise (paywall):

The computer games retailer has been touted as a possible target for US rival Gamestop, However, traders reckoned Tuesday’s advance owed more to short sellers closing their positions.

Why being in the flow matters

One of the few things I miss about being in the City is being in the flow. Being in the flow means knowing what is going on – and why. It means having access to equity traders and salespeople who are talking to global investors for every minute of every day. They know why markets move, why stocks are jumping, what investors are saying.

I am more in the flow than I have ever been for games news, for venture capital deals, for industry gossip. But not for the public markets. (To be fair, the rules have got a lot tougher since I was in the City. I used to know information that would be in breach of Chinese Walls these days).

Why short sellers closed their positions in GAME

By the sounds of things, a rumour hit the market yesterday that GAME might be a target. It also sounds as if a lot of people were shorting the stock.

Shorting a stock means selling stock that you don’t own in the expectation that the price will fall and you will be able to buy back the stock for less than you sold it. It is an entirely legitimate technique for speculating that the price of a stock will fall, and benefiting from that fall. I’m not surprised that GAME Group is a target for short-selling. It’s in my list of Ten games companies that are doomed, and I think that the retail model is seriously challenged.

It has a down side, though. If the share price suddenly rises, a short seller can lose a lot of money. Much more than a buyer of the stock. The worst that can happen to a buyer is that the company goes bust, in which case they lose all of their money. A short seller can lose much more than that.

The reason is that there is a limited downside to a stock (it can only go to zero) but an unlimited upside. A stock can go up and up. If a share price doubles, or triples, a short seller can find himself owing a lot of money in a short period of time. (If you are interested, read the story of how the carmaker Porsche got one over the financial community – and made some where between $7.5 and $15 billion at the expense of traders and speculators – by executing a short squeeze on Volkswagen stock)

At the slightest sign of a bid rumour, short sellers scramble to get out.

Capitalism at work

This is exactly how it should be. Buyers push the price up. Sellers push it down. Short sellers put it down further – until the price reaches the point where a bid is viable. Then the short sellers know that they are at risk and scramble to get out. In the process, the stock market fulfils its most valuable functions: price discovery.

More broadly, it teaches us who are outside the flow to beware what we interpret. Traders say that GAME Group’s stock moved because of short sellers closing out a position, not because a bid is imminent. Similarly analysts notes rarely move markets and historic results don’t change prices (it’s expectations for the future that matter).

Be careful how you interpret stock market movements. Unless you are a professional in the flow, you are probably lacking the key datapoints.

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