Following the debacle of GameStop's short squeeze, several retail investors still do not understand exactly what happened, and some of them actually believe there was a short ladder attack targetting the stock.
But what is a short ladder attack? Up until this point in time, no finance professional has ever heard this term. Let’s look at what is behind this new concept, and what we can learn about it.
What is a short ladder attack?
A short ladder attack is a concentrated effort by several entities to manipulate the price of a certain asset or a stock, by shorting it. The idea was popularized following the abrupt decline in GameStop stock right after what seemed like an infinity short squeeze that was about to happen.
The truth is that there are no infinity short squeezes, and eventually GameStop stock price would decline, although some retail investors thought the stock could continue to go up in price indefinitely.
Although a short ladder attack is still considered a myth by most market participants, there are clearly some situations where “short attacks” are conducted.
What are short attacks?
Short attacks commonly describe situations where a stock is targeted by activist short-sellers. This includes the release of a short report on the company, in order to push the stock price down.
Perhaps one of the most iconic short attacks ever conducted was when Bill Ackman shorted Herbalife. The short was highly publicized in the media, and eventually attracted other investors who thought the stock should be bought at those levels - Carl Icahn.
The Herbalife short squeeze shows us exactly how a short ladder attack resembles a myth and a conspiracy theory-fueled narrative that does not have any basis.
Why short ladder attacks are a conspiracy theory?
Whenever there is a transaction in the market there are always two parties, one seller and one buyer. Each has opposing views, and that is how the market operates. Stock prices move due to consensus among market participants. There could be more market participants that believe a certain stock should go up. However, they do not control most of the capital.
This is how the conspiracy theory surrounding GameStop started. Retail investors who poured their hard-earned savings into the stock failed to understand that the market reflects the consensus of those that have the most capital to deploy.
If a stock is down, it means that most of the money in the market thinks it should go down. What the Herbalife short squeeze shows us is that whenever there is a discrepancy between the value of a certain security, and a “short attack” other investors will come in and buy the stock. Unless they feel that the company is not worth that much money.
That is why the GameStop short squeeze was short-lived. The company reached a totally unrealistic valuation that could not attract any more buyers. Due to the overvaluation short sellers piled in, believing the company was worth a lot less than the market price.
Although it may seem like there are some evil hedge fund managers pulling strings behind the market, and manipulating stock prices to benefit themselves, this is impossible. If the stock should be higher, there would be other hedge funds looking to start long positions on the stock.
Some retail investors even believe that these short ladder attacks were conducted on several stocks beyond GameStop like AMC and Bed Bath and Beyond. This makes this claim even more implausible since it would be nearly impossible to manipulate the price of one security let alone several.
How do you get rid of short-sellers?
It is impossible to get rid of short-sellers unless the government bans short-selling. It has happened in the past, during the 2008 financial crisis short selling financial stocks was banned for a brief period.
Although the SEC advocated that it was trying to protect investors and the market, the reality is that these financial stocks immediately started climbing higher. Leaving many investors that were short financials with huge losses.
Although the situation was unique, it seemed like the SEC took abrupt measures that were unjustified.
“You can’t change the rules of the game while the game is going on.”
During the 2020 stock market crash, short selling was also banned in European markets, with some regulators advocating that short sellers were driving prices lower. However, there were clear consequences to the European markets, especially when compared with other markets that had no restrictions on short selling.
Every market participant should be thankful that short selling exists because short sellers are extremely important.
Are short ladder attacks legal?
No, even if short ladder attacks were real they would still be legal. In the same way that the GameStop short squeeze was not illegal. If there is a concentrated effort by several investors to drive the price of a stock up, and that is not illegal, why would it be illegal for other investors to do the opposite thing and drive the price down?
What is illegal is to publicly share false information about a company, and then benefit from it by shorting the stock. This is what is called a short-and-distort, and the SEC has charged individuals in the past due to this.
Are short ladder attacks real?
There is no clear answer to this question. Since there is no evidence that short ladder attacks on stocks like GameStop, AMC, and Bed Bath and Beyond are real. The key point is that even if these short ladder attacks were real, they would be no different than the Reddit attempt to push meme stocks higher. If “long ladder attacks” are not real, why would “short ladder attacks” be real?
Although there is still a lot of speculation surrounding short ladder attacks, the reality is that they are nothing but a conspiracy theory. In order to deem this kind of attack illegal, you would also have to ban the opposite.
What seemed like a short ladder attack on GME was nothing but investors selling and taking profits. While traders took sizeable short positions to benefit from the expected decline. As the prices decline a lot of investors fearing even more declines started selling, and those who were trading with margin started getting margin calls. This is another reason why you should avoid investing or trading with margin since it can put you in debt.