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GameStop Stock: Why Its Liquidity Has Been Declining Big-Time

GME's trading volume has been in a downtrend since mid-year. Here is why retail investors might be behind the drop.
  • Since May, trading volume in GameStop's stock has been declining in each consecutive month.
  • Many retail investors are registering their GME shares through the Direct Registration Service, which has an impact on the stock's liquidity.
  • Despite its lower liquidity, GameStop continues to be a popular target for short sellers and a money-maker for stock lenders.
Figure 1: GameStop Stock: Why Its Liquidity Has Been Declining Big-Time

Figure 1: GameStop Stock: Why Its Liquidity Has Been Declining Big-Time

GME's Monthly Trading Volume Declining

Looking at GameStop's  (GME) - Get Free Report trading volume data for 2022, we can clearly see a decline in trading activity since May. See below:

Figure 2: GME's monthly trading volume YTD.

Figure 2: GME's monthly trading volume YTD.

GameStop's liquidity peak occurred in March, when news of its 4:1 stock split broke. That also coincided with a rally in the S&P 500. From mid to late March, the video game retailer's shares shot up 140%.

Because GameStop is a popular target for short sellers — the latest update showed about $1.5 billion betting against its stock — increased buying activity tends to pressure short sellers to close their positions and buy the stock to cover their margins. This triggers noticeable upward movements in the stock.

Despite some fairly severe price swings this year, GameStop's trading volume has fallen more than sixfold, from 636.57 million shares traded in March to 102.97 million shares traded in October.

The most likely cause of this liquidity decline is broader market forces. Thanks to rising interest rates, many investors are avoiding stocks — especially those that trade less on fundamentals and more on growth or speculation.

Is DRS Behind the Liquidity Decrease?

There's another factor that has impacted the liquidity of GameStop shares. It is at the very least unusual, but not bearish at all.

GameStop shareholders are actively utilizing the Direct Registration System (DRS) service, which provides shareholders with the ability to electronically move insured shares in a book-entry form between the share issuer and the investor's broker-dealer.

In other words: with this service, GameStop investors have found a way to lock up their shares without the need to have a brokerage house behind them.

Even though it is less practical to sell your shares this way than through a broker, there are logical benefits to registering your shares through DRS.

For example, investors can keep their shares away from possible conflicts of interest between market makers and payment-per-order-flow brokers, as well as to protect themselves in case the broker-dealer goes bankrupt.

However, the main benefit may be to limit the ability of brokerages to lend shares to short sellers — which is a common practice.

In theory, if enough retail investors use DRS to transfer their shares to a transfer agent, share availability will decrease. Thus, it will become difficult for short sellers to cover their positions in an eventual squeeze.

Interestingly, GameStop has started to disclose the number of shares transferred directly with its transfer agent on a quarterly basis. And the numbers are alarming.

According to data from July 30, as stated in GameStop's latest Form 10-Q, about 71.3 million shares are registered directly through the DRS. That number could be even higher by now.

This amount corresponds to about 30% of GameStop's total float, which implies that, in theory, these shares are not liquid enough to be traded daily. This can be confirmed by looking at the trading volume trend of GME in the last few months.

We can speculate that, when GameStop reports its fourth-quarter earnings results, the first number that shareholders will probably look at will be the number of shares transferred through its transfer agent.

How GameStop Lenders Made Money in Q3

It's not news that GameStop is one of the most popular stocks for short sellers to bet against — thanks mainly to its meme-stock valuation.

With the markets in turmoil, many institutional investors have been targeting stocks whose valuations are detached from their fundamentals. Of course, GameStop is one of them.

The latest GameStop short interest data from mid-October indicated that 20% of GME's float — 53.88 million shares — was being sold short.

During October, GameStop's borrow fee rates remained at an average of 9%. Even though these fees are lower than earlier this year, they're still high. This puts extra pressure on short sellers to cover their positions in case of an upward stock movement.

Despite the efforts of GameStop shareholders to limit stock lending to short sellers, GameStop was the most profitable equity in the North American lender market, generating more than $100 million in revenue for lenders. A large part of these profits came from GameStop's high borrow fees.