The theme of the past week has been short squeezes. Many are treating this as some sort of new development but these short squeezes tend to happen during the frothy stages of bull markets. What is unique is that this may be the first time that a squeeze was organized and coordinated via social media.

However, while many in the mainstream media are painting this as some sort of David vs Goliath battle, the reality is that the traders from Reddit's r/WallStreetBets accounted for a marginal share of the buying power. The majority of flows came from institutional funds, so it was more of a hedge fund vs hedge fund battle. Once, hedge funds became aware of the precarious position of funds with heavy short positions in certain securities, they bid up these shares knowing that their downside was limited given that these funds would have to capitulate at some point. So, rather than David vs Goliath, the right metaphor is scavengers picking at a dying animal.

Secondary Impacts

Of course, the short squeeze trade is played out. Latecomers to the party are learning this the hard way as some of the stocks with the biggest squeezes like Gamestop (GME  ), Bed Bath and Beyond (BBBY  ), or AMC (AMC  ) have already given up the bulk of last week's gains.

However, one probable impact from this episode is that it will force many long-short funds to de-risk. Many of these funds will use leverage to get 200% long and then 200% short or even more extreme ratios. Under normal conditions, this is a fantastic strategy for money managers to earn outsized returns with neutral market exposure. However, under last week's conditions, this seemingly risk-free strategy can lead to serious destruction of capital. For example, Melvin Capital was reported to be down 57% with most of its losses coming in the last week of January.

So, if investors pull their money out of these funds, it's possible that it could spark a selloff on Wall Street. Essentially, these funds short the worst companies and buy the best. It could lead to selling in blue-chips like Apple (AAPL  ) and Amazon (AMZN  ) due to funds being forced to liquidate their positions in order to meet redemptions.

Another possibility is that this has become a rare area of bipartisan agreement. Politicians on both sides of the aisle were outraged by brokerages restricting trading in shares of certain stocks. This could be an opening for politicians to increase regulations and/or increase taxes on capital gains. This could lead to profit-taking on Wall Street as well.