Seeing lots of explainers about the reddit/hedge fund drama right now, and as someone who worked as a quant for a big fund for 7 years, figured I'd chime in. This whole situation is pretty much why I quit. Big thread.

First, what's happening? At the simplest level, hedge funds "short" stocks. That is, they borrow stock, sell it, and have to buy it again later to return it to the borrower. If the price falls during that time, they make a profit.

It's an effective way to make money from falling prices. But it also has enormous risk. Normally, if you put $100 in a stock, all you can lose is that $100. But if you short a stock and it goes to the moon, your losses are unlimited.

Consider $GME, Gamestop. Let's say a fund shorted it when it was $40. When the price spiked to $470 today, they'd be facing a LOSS of $430 on that $40 investment. If they shorted it for, say, $10M, they'd be facing a loss of >$100M.

But it gets worse. Let's say an institution BORROWED money and then used that loan to short the stock. That's called leverage. Before the GFC, banks were running at ~33x leverage ratios. For every $1 they owned, they'd invested $33.