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Short Selling Unpopular GameStop Stock (NYSE: GME) Hasn't Paid Off – Yet By Jim Bach

GameStop stock (NYSE: GME) is a short selling favorite, and for good reason. It's trying to navigate an online-centric marketplace as a physical retailer, and the short bets are playing off this knowledge to mount a strong position against the company. The post Short Selling Unpopular GameStop Stock (NYSE: GME) Hasn't Paid Off – Yet appeared first on Money Morning - Only the News You Can Profit From .

GameStop Corp. (NYSE: GME) is a popular target for short selling. Over the past few years it has continuously been among the most heavily shorted stocks in the S&P 500, according to Bespoke Investment Group.

Short sellers are betting that the company's once unchallenged dominance in the videogame selling and reselling business will fold as it faces the onslaught of downloadable content and digital delivery.

But despite the expectation that GME was resigned to this fate, the small, but growing, threat of digital competition has yet to deliver a knockout to the retailer's traditional brick-and-mortar videogame business. While the bears have secured some short-term victories, their tendency to pile on with the short selling herd has continued to be their Achilles' heel.

Last year, the shorts were battered by GME's seeming unwillingness to let weak earnings data eat away at its market cap. In spring 2013, GME had reported its worst year in recorded earnings history, with a 7% decline in sales, and finished the year $269.8 million in the red. Yet the stock still soared. From the date of the earnings release to its November 2013 peak, it gained 93.1%.

GME's shares climbed 40.6% from the beginning of 2013 to the end of April 2013, when short selling comprised a heavy 34% of GME shares floated. A correction looked to be looming - so short sellers were salivating at the opportunity to get in on the bet.

But the opposite happened, as GME stock continued to soar. It advanced another 12.7% and was trading at an adjusted close of $37.91 in mid-June, up from $23.92 in the beginning of the year. This surge did work to shake out some of the shorts - the short float had fallen to 30.8% - but they still largely held on.

That is, until the "short squeeze" happened...

How the Short Squeeze Scared Off GME Doubters

To short a stock, a trader must borrow shares from a broker, sell them at market value, then buy them back at a later date and return those borrowed shares back to the broker. The intent is to buy back those shares at a lower price and pocket the difference, thus making a profit off a company's falling value.

But for a short seller, there is no ceiling on losses. An investor buying a stock can only lose the amount of money that's invested, but a short seller will continue to lose as the price goes up. And if a stock skyrockets, the short seller tends to panic and buy long to cover the position and stop the bleeding.

When a heavy volume of short sellers panic en masse, this added long buying will provide a further jolt to a stock's upward trajectory in what is called a "short squeeze."

This is what happened to GME's stock last year.

From mid-June 2013 to the end of August 2013, GME shares rose from $37.91 to $49.06, and continued to push above $50 thereafter. Short float fell from above 30% to around 16%. The shorts had been squeezed and GME's supposed aging business model prevailed.

So what's next for this resilient stock?

Don't Put the Nail in GME's Coffin Just Yet

The trends are not in GME's favor. Money Morning's Defense and Tech Specialist Michael Robinson said that gaming is becoming increasingly more "online centric," and online sales are filling the vacuum left by continual year-over-year declines in showroom customers at retail stores.

"This is not a good time to be invested in physical retail," Robinson said. "The balance of power has shifted to e-commerce."

But tailoring a short play to the downfall of GME is unwise even if it does have unfriendly market forces to contend with. It is still a specialty store and a leader in its industry, making the Hail Mary short play all the more difficult.

"Even candidates that look to make sense where you can justify shorting it don't always work out," said Money Morning Capital Wave Strategist Shah Gilani, also editor of Short-Side Fortunes advisory services. "It's rare that you're ever so right that you throw everything you have in a trade."

What is likely to happen is GME will continue to be a playground for traders looking to play the short squeeze pattern - to beat the short seller herd before it catches on.

Since April last year, when short positions were growing on GME, there has statistically been a near-perfect inverse correlation between the number of shorts and GME's share price. This means as the shorts begin to mount, the stock begins to lose value.

But when shorts reach all-time highs, GME's price is at all-time lows, due for a rally and poised to experience another short squeeze.

Bottom line: While the stock keeps climbing, this is not a good long-term play. And unless you are experienced with trading in these short-squeeze scenarios, don't jump in the game. There are much better places to profit in this market - like here, here, and here.

More on short selling: The conventional approach to trading is to buy low and sell high, but what the conventional approach doesn't account for is that there are two sides to every trade. Wall Street has made quadruple-digit gains by taking the other side of the trade and Money Morning Members can learn how, too, with The Absolute Beginner's Guide to Short Selling...

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The post Short Selling Unpopular GameStop Stock (NYSE: GME) Hasn't Paid Off – Yet appeared first on Money Morning - Only the News You Can Profit From.

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