The Stock Market Crash of 2021 Simply Explained
Disclosure: All opinions presented here are purely my own and do not represent my firm or anyone associated with it. This is not a recommendation. Do your own homework and due diligence before investing in anything.
First posted on my personal website (here).
Been writing about this topic for a few months now and every day that passes by, I’m growing more and more convinced this is coming.
A great market crash is upon us.
If you haven’t read my other articles about this topic, check them out here:
Part 1: Power of the Retail Investor — Gamestop stock situation explained
Part 2: How Redditors and retail investors could pop the stock market bubble
Part 3: The Next Big Short Explained — AMC & Gamestop.
With this post, I want to try and explain how this happens as simply as possible.
Let’s begin
What happened in the last year?
Covid.
Because of Covid, the US stock market had a mini-collapse in March 2020.
The US government was scared the stock market would plummet even more.
So Trump and the US Congress signed the CARES act.
They injected 2.2 trillion dollars into the economy.
Where does this money go?
This money is mostly assigned to the banks.
What do banks do with the money?
They loan it out.
When interest rates are at 0%, money is basically free.
The amount you pay in interest is so low that it’s worth borrowing money.
For a lot of people, this was to save their business, buy a house or survive.
However, through prime brokers, the big banks loaned a lot of money out to hedge funds.
What are hedge funds?
Hedge funds are essentially when a lot of people give money to a few people to play more risky strategies in the stock market.
Their goal is to generate ‘alpha’, which is a fancy way of saying they can beat the general stock market.
Most don’t.
These hedge funds are given leverage, which means they can borrow money from the bank.
For every dollar they raise from others, the bank will let them borrow 3–5 dollars.
If a hedge fund raises 10 billion dollars, that means they have the ability to borrow and invest 30–50 billion dollars in the market.
Some hedge funds are massive.
Collectively, they control trillions of dollars in market value.
Because of the printing of money in the last year, banks have been over-leveraged.
They’ve given out more money than they should have.
The question of how much they’re over-leveraged is unknown now.
But I assume a lot.
Why?
Because Bill Hwang.
Bill Hwang was worth 20 billion dollars.
How?
He got margin called.
What’s ‘margin called’?
It’s when stocks the hedge fund owns drop below a certain price point so the hedge fund needs to deposit more money in their account in order to not go bankrupt.
Where does the money come from?
It comes from them selling other stocks in their account.
Why would they have to sell stocks in their account?
Because they’re going to get short squeezed.
AMC, Gamestop and possibly others.
Hedge funds tried to short these companies.
They bet on these companies failing.
How do they bet on companies to fail?
They borrow shares from brokers.
When brokers ask for their shares back, the hedge fund has to pay them the amount they borrowed.
What if the stock jumps higher?
It means hedge funds have to buy shares in the market in order to pay their brokers.
What if people aren’t selling shares?
It means hedge funds have to pay more money to buy the shares.
Where does this money come from?
It comes from selling other stocks in their account.
Remember, hedge funds control trillions of dollars.
When stocks that have gone up significantly in the last few years like Tesla start to decline, people get nervous.
Do you know what people hate to lose?
Money.
When people start losing money in the market, they will sell.
Loss aversion — people hate losing more than they like winning.
More people have signed up to be in the stock market in the last year.
More money is being pushed into the market.
The more people invest, the higher it goes up.
The higher it goes up, the bigger the bubble.
The bubble is ready to pop.
Why?
Hedge funds will crash the market because a bunch of people on the Internet bought and held a few stocks.
What a crazy world we live in.
Keep Going, You’re Doing Great
-AK
