Elon Musk has joined a swarm of small retail stock market players who are buying beaten up stocks that have been prevailed upon by short sellers. The end-result is that these short sellers, who are often seen as exploitative pirates robbing long term ‘buy and hold’ investors, are now crying out for help!

Wall Street has always been made up of three groups: those who buy and hold stocks; traders who buy and sell often; and short sellers who look at a company, think it’s overvalued and then try to sell the stock ‘big time’ to bring its share price down. When they do this, they make money, while others lose it.

Now small investors chatting on Reddit (an online forum) are encouraging small investors to buy stocks the short sellers have targeted. These small investors have not only raised the share price, they’ve forced the short sellers to buy to avoid losing money.

A stock like GameStop in the US was at first hit by short sellers. But after Elon Musk joined in with other Reddit readers, the stock price was up 93% on Tuesday and up another 50% the next day. And the short sellers are crying all the way to the bank! The involvement of Musk amplified the buying by small investors.

A couple of weeks ago, a short seller targeted a local company called Tyro Payments after it had a problem with its terminals that are used for card payments in many small businesses, especially in the hospitality sector.

I’m interested in this because I’m an investor in Tyro after many of my fund manager mates told me on air during an episode of our Switzer TV Investing show that Tyro was a good company they were investing in.

The short seller is called Viceroy Research and is based overseas. It published a report, criticising the company, which they gave to journalists before the general  stock market opened and then released it at 11am to market players. The report hurt the share price, which slumped 12% in an hour!

No one tested their views, so logically many investors (professional fund managers and retail investors who watch the market closely) would’ve sold first and asked questions later. This chart below shows what’s happened to the stock.

Tyro one month

The fall started with the company admitting to the terminal problem. But the drop intensified with the report. Then it recovered, after the company’s CEO, underlined 10 false statements in the Viceroy report.

The market now awaits the testing of the report’s claims, which could be determined by how many clients Tyro loses and what happens to its revenue, as well as the costs of compensating their negatively-affected customers.

Gerry Harvey, founder of Harvey Norman, has seen his company targeted by an overseas-based hedge fund/ short seller. He says their claims are false and if they were locally-based, he’d sue them.

It raises a lot of question about the ethics of short sellers. Right now, there’s a petition here in Australia to stop short selling but it’s very unlikely that it will be banned. Short sellers can be market manipulators but they’re seen as useful to stock markets because they stop stocks being overbought.

I don’t want to debate this issue but simply explain that some short sellers are whistle blowers on ordinary or bad companies that have been overhyped, while others are exploiters simply trying to make money at the expense of others.

I’d like to see regulation improved to make sure short sellers are honest brokers and not manipulators, but that’s something that the ASX, ASIC and the Federal Government should be involved in.

Apparently over in the US, the new Treasury Secretary, Janet Yellen, is watching these short sellers, with GameStop being trumped by small retailers. Yellen is concerned that it could get out of hand.

Before the close, the Dow Jones Index was down over 400 points and market experts are partly blaming it on this speculative trading linked to Reddit.

The fear is hedge funds, which are big short sellers, could be bankrupted, which would lead to a wider stock market sell off. If these funds got into trouble, they’d have to sell their stock and that would force share prices down.

Interesting, short seller Michael Burry (the movie The Big Short is based on Burry) recently tweeted that trading in GameStop is “unnatural, insane, and dangerous” and there should be “legal and regulatory repercussions.”

Burry, who’s the founder and boss of Scion Asset Management, made $750 million in profits for his investors and $100 million personally when his bet against subprime mortgages paid off in 2007 and 2008 around the time of the GFC.

Interestingly, as I’ve explained, short sellers are renowned for creating reports on companies to ‘spook’ the stock market so they can make money. What’s going on now (with small stock players inspired by Reddit) means these short sellers are copping some of their own medicine. However, for the sake of all investors, you don’t want this to get out of hand!