What was the biggest bet you lost?

Wirecard, Sino Forest, Enron: Successful short attacks against companies that later went bankrupt have what it takes to become legend, the short sellers on Wall Street have hero status. Hardly anyone suspects that many can ruin themselves. The business of short sellers is rightly considered the supreme discipline on the stock market. The short seller has to be very sure of his cause, because he has an unlimited risk of loss.

That's the nature of business. The short seller borrows a share and sells it immediately. If their price falls - and the shortseller sales can trigger or increase this - he buys them back cheaper on the market and then delivers them to the person who loaned them to him. He always has to give it back. If the share rises, he can at some point lose his nerve, because buying back the paper will then become more and more expensive.

If you buy and hold shares, you lose your stake in the worst case. A short seller, however, can lose an infinite amount of money - after all, a share can also rise by 1,000 or 100,000 percent. If such a nightmare scenario suggests itself, all shortsellers push to the exit at the same time, so they want to buy the share and give it back before it becomes priceless. But if everyone wants to buy, the price rises rapidly - this is the classic shortsqueeze that small investors in particular have triggered and are enjoying right now with the video game stock Gamestop.

In the hype surrounding Gamestop, a group of small gamblers is throwing billions in hedge funds into trouble. What investors can learn from it.

What is fascinating about the Gamestop case is that small investors have organized themselves on the Internet in order to drive the hedge funds into the shortsqueeze - a fight of many little Davids against some Wall Street Goliaths. In the past, short sellers were mostly dealing with bigger players: regulators, corporations, banks or rival hedge funds. Here are three famous shortsqueezes from the past:

Porsche / VW: The hedge funds find their master

In September 2005, the then Porsche boss Wendelin Wiedeking announced that Porsche would join VW. For a long time he gave the impression that Porsche would be content with a quarter of VW. Largely unnoticed, however, Porsche secured 74.1 percent of VW, largely through options. When Wiedeking made this public in autumn 2008, it gave the share a boost - many investors speculated on a complete takeover. Hedge funds that had bet on a falling VW price had to stock up - and lost billions when the VW price shot in the short squeeze to over 1000 euros.

They had found their master in Wiedeking's congenial CFO Holger Härter. For a short time, VW became the most valuable company in the world. Around 40 hedge funds alleged in court that Wiedeking and Porsche as a whole had manipulated the market by forcing them to buy VW shares at an inflated price. The hedge funds - led by the fund companies Elliott Associates and Black Diamond Offshore - claimed damage of around two billion dollars. The funds have not seen any money to this day.

Small investors have landed a curious coup with arranged short squeezes. But bubbles burst. Then: save yourself who can. For the remaining shareholders, what they bought suddenly becomes relevant.

US banks: regulators intervene

In July 2008, in the middle of the financial crisis, the US Securities and Exchange Commission unpacked the bazooka. It tightened the rules to which shortsellers are subject and issued a ban on uncovered short sales ("naked shorts"). Uncovered short sales on stocks of 19 systemically important US banks from Goldman Sachs to Merrill Lynch to Lehman Brothers were prohibited. Their prices had previously come under massive pressure from shortsellers. With naked shorts, hedge funds can sell stocks that they didn't even have to borrow before - they just have to get them at a later date. This can very quickly lead to very large waves of sales. As is now the case with Gamestop, even more stocks can be sold on short sales than exist at all. In 2008, the SEC's ban led to forced buy-in and a massive short squeeze that at times pushed US bank stocks up by over 30 percent.

Tesla: unicorn versus musk

One of the most famous shortsellers, who made billions in the financial crisis, is hedge fund manager David Einhorn of Greenlight Capital. At the electric car manufacturer Tesla, however, he has no luck. Short sellers have repeatedly shorted Tesla shares - no wonder, given the gigantic price increases and justified doubts about the sustainability of sales and profits.

Tesla boss Elon Musk had initially complained about shortsellers, but in the end he was able to make fun of them. Again and again Tesla surprised with unexpectedly positive news that pulled the price up and provoked some shortsqueeze. Most recently, Musk even added shorts to the Tesla online shop - and recommended them to Einhorn. Einhorn first bet against Tesla in 2017, when the share still costs around $ 50 (today: over $ 800). The analysis house S3 Partner estimated the losses of the shortsellers as early as July 2020 at over 20 billion dollars.

Unlike many other shortsellers, Einhorn has not yet closed his position against Tesla. In the letter he sent to his investors a few days ago, Einhorn called the Tesla bet his worst position in the otherwise good year 2020. No wonder: Tesla grew by almost 750 percent in 2020 alone. Einhorn dropped his bet shortly before Tesla was included in the S & P500 stock index. Hedge fund legend Jim Chanos also reduced his short position in December by buying back shares and delivering them to lenders. "Painful" is what he called the Tesla bet.

Shortselling is also a question of timing and perseverance. At some point the short bet against Tesla will also work, but until then there will be no abrupt, violent shortsqueeze, but a very slow, painful squeeze.

More on the subject:Small investors have landed a curious coup with arranged short squeezes. But bubbles burst. Then: save yourself who can. For the remaining shareholders, what they bought suddenly becomes relevant.

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