What is a meme stock?

Definition and Examples of Meme Stocks

How do meme stocks work?

Notable Events: GameStop

What does this mean for individual investors?

Definition and Examples of Meme Stocks

A meme stock is a stock that gains widespread popularity online, attracting the attention of individual investors. A meme stock is a security that has seen an increase in trading volume after becoming viral on social media or an online forum. Meme stocks have become increasingly popular thanks in large part to the Reddit page known as WallStreetBets. The popular meme stock GameStop (GME) saw a significant surge in its price at the end of January 2021 after individual investors attempted to counter a short-selling hedge fund on the stock. Although meme stocks generate increased individual interest in the stock market, experts advise a more diversified and thoughtful investment approach.

How do meme stocks work?

The popularity of meme stocks is driven by discussions taking place online. News spreads quickly online, and when a stock becomes popular through word of mouth, it experiences a rapid increase in price. Because the subsequent price increase is artificial and not a result of the company’s actual performance, such gains are often followed by an inevitable collapse.

These increases were fueled in January 2021 by a forum on Reddit called WallStreetBets. In a thread on the WallStreetBets subreddit, one user explained the lifecycle of a meme stock as follows:

Early Stage: A few investors believe that a certain stock is undervalued, so they start buying it in large quantities. Prices begin to rise slowly.

Middle Stage: People monitoring the market and following these stocks begin to notice an increase in trading volume. More people start buying, and stock prices rise significantly.

Late Stage / Fear of Missing Out Stage: News about the stock spreads across social media and online forums. People fear that they will miss out, and thus, more individual investors join in.

Profit-Taking Stage: After several days, buying reaches a peak, and people who entered the market early start pulling their money out. The selling phase becomes a chain reaction as people fear losing money. This is the moment when prices begin to drop.

Because of this cycle, the real beneficiaries of these trending stocks are the early investors. Once a meme stock cycle enters the fear of missing out phase, it is very likely that it is too late to make a profit.

It’s worth noting that Reddit is a community platform where people from around the world can write whatever they want. Although there are rules to prevent things like inciting violence or illegal trades, they are not enforced widely. Keep this in mind when reading content on various Reddit forums.

Meme Stock: GameStop

GameStop became perhaps the most famous meme stock in January 2021 when its price skyrocketed by hundreds of dollars within a few days. Users of the WallStreetBets forum began buying GameStop shares after learning that a hedge fund was short-selling the stock.

Let’s take a look at this increase. At the beginning of January 2021, the price of GameStop (GME) was $17.25 – a stable price throughout 2020. Then, about 20 days later, the GME growth driven by online hype became clear: on January 26, GME reached $147.98 at the market close, compared to $76.79 the previous day and $39.36 just one week prior.

Also

On January 26, Tesla’s CEO Elon Musk shared a link to the subreddit WallStreetBets, where the hot topic was GME, with the comment “Gamestonk!!” Often, the cycle in meme stocks has been fueled by praise and admiration from public figures.

On the day following Musk’s tweet, the stock price surged again to new heights. GME’s price more than doubled to $347.51 on January 27. Then, on January 28, the stock reached a peak of $483 before dropping to $193.60 by the end of the day.

Short selling is when an investor—often an institutional investor like a hedge fund—borrows a stock and sells it, aiming to buy it back to return it. When someone shorts a stock, they are betting that the stock’s price will decline between the time they sell it and when they buy it back.

Lynch explained the process of short selling a stock with a simple example: It’s like what would happen if she sold her husband’s Nike Jordan shoes to someone at full price, intending to buy them back for a lower price at the mall and keep the profit.

Except in the case of GME, the short-selling plans of hedge funds did not go well due to many individual investors joining in to buy.

As could be expected, the GameStop story attracted a lot of legal scrutiny. The House Financial Services Committee and the Department of Justice launched deeper investigations into the events surrounding this surge. Major brokers, like Robinhood, used by ordinary investors to participate in this trading frenzy, chose to restrict trading in GME and some other meme stocks. The CEO of Robinhood stated that the restrictions were to help the brokerage meet increased regulatory deposit requirements.

Additionally, the event raised doubts about Wall Street strategies, as well as the ethics of the relationship between traditional financial markets and current investors.

What does it mean for individual investors?

One visible outcome of the meme stock saga is the increased interest in retail investing. Despite the actions of Robinhood and other brokerage firms, the number of downloads of those apps surged dramatically following the events related to GameStop. The Robinhood app alone was downloaded more than a million times in the last week of January when the stock price surged and then later dropped, according to several media outlets, including Barron’s.

This spike in retail trading activity also prompted the U.S. Securities and Exchange Commission to issue a warning to investors. The warning cautioned people about the risks of investing in “hot stocks” or “short-term investments based on social media.”

There’s no doubt it can be exciting to make money from day trading and to be part of something bigger, like the GameStop case. However, studies have shown that even the most experienced traders lose money. Therefore, while it may be great that meme stocks have increased interest in the stock market, experts recommend following a more cautious and thoughtful investment strategy.

“The biggest piece of advice I would give to individual investors is to invest for the long term,” according to Elizabeth Westendorf of Atwood Financial Planning in an email to The Balance. “Don’t chase short-term profits; aim for long-term growth. Additionally, remember that if you’re saving money in a retirement plan, you’re already investing! Focus on building those investments rather than chasing the latest fad. It should be
Source: https://www.thebalancemoney.com/what-is-a-meme-stock-5118074