Meme Stocks – Are they more than just a pandemic trend?
What is a meme stock?
A meme stock is a stock that goes viral online and sees a dramatic increase in volume and price. The increase is unrelated to the company’s performance but occurs because of the hype on social media and online forums. Ultimately, the stock becomes overvalued.
Some common characteristics of meme stocks include:
- They are overpriced
- They experience spikes of rapid growth in a short amount of time
- They are popular with millennials and Gen-Zers
- They are prone to high volatility with valuations based on perceived potential rather than financials
How did the meme stock movement gain momentum?
Meme stocks found their origin in the pandemic and were fueled by commission-free trading and the online investing community. Commission-free trading, initiated by companies like Robinhood and Stash, have allowed a wider audience to enter the stock market at any level. Online investing communities, found on social media sites such as Reddit and Stocktwits, have millions of members who can easily pass information among their communities. Once the pandemic hit, people were at home, with stimulus checks in hand, communicating seamlessly on social media.
The Short Squeeze
The meme stock community has been known to target ‘short’ interest stocks in an effort to ‘squeeze’ anyone who has been shorting the stock into covering their short, which in turn drives up the share price as they close out positions to cover their losses. Take GameStop (GME) for example:
GameStop was trending downward. The pandemic hit the company hard, forcing it to close locations, reducing foot traffic, and causing significant reductions in revenue and earnings. Institutional investors saw an opportunity to short the stock. This means they borrowed shares from investors who owned the stock and sold them immediately in the open market in hopes of buying them back later at a lower price. The short sellers would take home the difference between the two prices as profit. However, retail investors were not happy that their shares were being bought to drive down the share price. A group on WallStreetBets took their concerns to the public and urged everyone to buy the stock so the hedge funds and other institutional investors would have to buy back the shares at higher prices. The rallying cry worked. GameStop reached an all-time high of $483 on January 28, 2021, after trading between $17 and $20 in early January. By January 29, 2021, the hedge funds that shorted the stock had lost $19.75 billion according to CNBC. As retail investors got the upper hand, memes started appearing on social media and the term “meme stock” was coined.
According to some, the “meme-stock movement” is a “social uprising in challenging the status quo and the norms.” Through this movement, retail investors have established that they can mobilize a lot of capital relatively quickly and dramatically influence stock price movements.
Other examples of meme stocks include AMC Entertainment Holdings, Inc. (AMC), which rose from a low of $12.18 on May 24, to a high of $72.62 on June 2, before dropping to $37.66 the next day, Bed Bath and Beyond (BBB), Clover Health (CLOV), and Wendy’s (WEN).
How do meme stocks work?
As explained on the WallStreetBets subreddit, the meme stock cycle is as follows:
- Early adopter phase: This is where retail investors identify an undervalued company and place buy orders.
- Middle phase: At this point, the stock gains attention from other traders who join the process, causing the share price to elevate further.
- Late/FOMO (fear of missing out) phase: By now, the stock has gained viral attention and investors late to the process purchase shares in fear of missing out on potential profits.
- Profit-taking phase:After a few days, the buying peaks, and the early investors close out positions, creating a new panic-selling phase, as investors do not want to lose money when the share price starts to fall.
What is the SEC’s take on meme stocks?
Currently, the SEC makes sure that companies do not disseminate materially misleading information, but the SEC does not regulate price, and it does not have the power to sanction individuals making recommendations on social medial message boards. Former SEC Chairman, Jay Clayton, has raised concerns over “the slivers of information that retail investors are buying and selling on,” and the new methods of trading and market communication raising the risk of new kinds of pump-and-dump schemes. To this end, the SEC can, and has, halted trading of securities that were promoted on social media for the sole purpose of inflating the stock.
The SEC has stated that it is observing the landscape for signs of disruptions to the market, manipulative trading, or other misconduct. Specifically, the SEC is investigating the trading activity of Gamestop and other companies and plans to release a report addressing these issues.
Gary Gensler, current SEC Chairman, says the SEC may even implement new rules for brokerage apps that turn stock trading into a game or contest.
Should you invest in meme stocks?
Each individual has to answer that question for themselves. If you do decide to dabble in meme stocks, be aware that these volatile stocks trade on speculation. The prices are superficial as they are created by viral engagement and they will inevitably crash. However, if you can pay attention to key communication channels, you may see a return on your investment.
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