Investing in Meme Stocks: How it Began – and When to Get Involved

  • Meme stocks are stocks that experience sudden, drastic price increases unrelated to their fundamentals or applicable news headlines
  • The meme stock craze kicked off in January 2021 thanks to a Reddit page called WallStreetBets, when a handful of Redditors decided to ensure that hedge funds taking short positions in GameStop, AMC, and BlackBerry would lose their investments
  • Since January, several “cycles” of meme stocks have come and gone, fueled by speculation and conversation on various internet forums and social media sites
  • While meme stocks promise riches for the lucky – and early – few, financial professionals tend to recommend that investors take a diversified, long-haul approach to building their wealth

What is a Meme Stock?

A meme stock is a stock that can fit almost any other classification: growth, value, industrial, small-cap, large-cap, or anything in between. These are stocks that spike in price and volume rapidly with little regard to the underlying firm’s fundamentals or value.

Meme stocks rose in popularity due to conversations and movements that originate in online forums such as Reddit’s WallStreetBets, various Twitter accounts (including Elon Musk’s own profile), and on TikTok. But because their prices are artificially bloated, they tend to crash soon after they soar, leaving thousands of (primarily retail) investors holding the bag.

The Rise (and Inevitable Fall) of Meme Stocks

Meme stocks got their start in a Reddit forum called WallStreetBets, which is frequented by day traders who share their ideas on securities, market moves, and the investments and divestments of institutional and wealthy investors.

In a paragraph, a group of day traders decided to engage in a “short squeeze” of GameStop’s stock after learning that a prominent hedge fund decided to short the stock (in essence, bet that the stock price would decline). To initiate the short squeeze, Reddit investors bought GameStop stock, which caused the price and volume to increase overnight. In turn, this attracted more investors, which sent the price higher, which began the circle once again.

But whereas past short squeezes have mostly been short-term, one-and-done deals, retail investors jumpstarted GameStop’s stock price from just $17 to over $500 in days – and dragged a dozen heavily-shorted securities and cryptocurrencies with them.

GameStop 1-year performance via CNBC
Blackberry 1-year performance via CNBC

The GameStop Saga: Aftermath

Since January, the meme stock craze has not only earned a name in the history books but has also come under fire from investors and regulators alike.

Part of the outcry descended upon the free investing app Robinhood, where thousands of investors flocked to take part in the GameStop saga – only to find that Robinhood had suspended all meme stock trades, citing the need to meet increased regulatory deposit requirements.

In response, critics and investors accused the platform and its peers of manipulating the market and serving Wall Street interests. (While disgruntled hedge funds and wealthy investors claimed that retail investors artificially inflated prices to serve opposing interests). More than a dozen class action lawsuits were brought against the firm, with claimants alleging that Robinhood’s restrictions prevented them from taking part in a profitable moment in the stock market.

Additionally, the House Financial Services Committee and the Justice Department both launched probes into both sides of the event to determine any evidence of market manipulation on either side. The SEC even issued an investor alert warning against “hot stock” trends, or short-term investing based on social media activities.

Meanwhile, public – and occasionally political – sentiment and speculation appear to have shifted against Wall Street’s wealth-building strategies as investors, traders, regulators, and scholars reexamine the relationship between retail investors, institutional investors, and modern-day financial markets.

But it’s not all bad news. The GameStop saga also appears to have reinvigorated interest in investment markets, which may lead to fairer market prices and increased wealth in the hands of the middle class – assuming that investors receive the tools they need to succeed.

3 (Temporarily) Profitable Meme Stocks Post-“GameStonk”

While GameStop was the original meme stock, a handful of other securities have since arisen in memeish fashion. There are two ways to measure the popularity of meme stocks: monitoring social media mentions and analyzing their stock charts.

AMC Entertainment Holdings (AMC)

AMC Entertainment is a rare example of a meme stock that’s played its cards right. While the entertainment stock had a small bounce in January, it roared back with a vengeance in early June as the company used its momentum to issue nearly $3 billion in new shares. The stock gained $30 in a day from June 1 to June 2, and though it’s trended lower since, AMC raised enough capital to reinvigorate its struggling business.

AMC Entertainment 1-year performance via CNBC

Carver Bancorp, Inc (CARV)

Carver Bancorp, Inc is a New York-based holding company that provides consumer and commercial banking services. The firm became a meme stock after Bloomberg, on 8 July,reported Carver to be a prime short squeeze opportunity due to short interest (as a percentage of equity float) had increased from 20% to 76% since May. The stock leapt 23% the next day.

Carver Bancorp 1-year performance via CNBC

SGOCO Group, Ltd. (SGOC)

SGOCO Group is a Hong-Kong based lending firm that holds stakes in a variety of businesses, including artificial intelligence, real estate, and energy saving technologies. It’s also the embodiment of a meme stock: after circulating in social media chatter in early July, the stock leapt 175% in a day despite no increases in earnings, sales, or underlying fundamentals. The move brought SGOCO up 1,800% YTD.

SGOCO Group 1-year performance via CNBC

Investor Sentiments Driving the First Meme Stock Movement

The meme stock movement seems unusual at first blush – why would retail investors choose now, and these stocks, to seek their riches and rail against institutional investors?

The answer is multi-faceted and incomplete, but a few potential factors may include:

  • Increased access to educational resources and brokerages, including free and low-cost investing apps like Robinhood and SoFi, as well as fractional share investing
  • The mounting wealth disparity of the 21st century, which was further compounded by the coronavirus pandemic
  • Retail investors’ anger at hedge funds, wealthy investors, and those they feel have taken advantage of them (or the markets – hence why retail investors descended upon a stock currently being shorted)
  • A realization that investors can exercise their voice in the market and to companies in which they invest

Additionally, our own Stephen Mathai-Davis, who runs Q.ai, has extensively surveyed thousands of online investors in all manner of forums and social media groups. And, based on his research, he posits a few theories of his own: chiefly, the idea that the meme stock “movement” is the result of retail investors’ distrust in a system that, in either suspicion or actuality, views them as “dumb money.”

Mathai-Davis’ research has also produced some helpful insights into the type of investors who rally around meme stocks. In surveying retail investors’ trade and research habits, he said, Q.ai discovered many investors need help in three key areas:

  • Trading in a dynamic environment
  • Learning when and how to cut their losses
  • Properly weighting portfolios

But by providing investors with the tools they need to succeed, as well as themes and portfolios designed for success, retail investors can move beyond meme stock and other speculative trades – and into patterns of building long-term wealth.

Why Do People Continue to Buy Meme Stocks?

If it wasn’t already obvious, here at Q.ai, we’re proponents of investing, not trading or speculating in individual stocks. And the differences carry significant ramifications.

Trading involves buying and selling stocks quickly to profit on short-term price movements. On the other hand, investing is the process of putting your capital to work in the market for the long haul, sometimes for decades.

But meme stocks aren’t intended to be long-term investments.

Instead, you might view meme stocks as a trader’s ultimate fantasy: a security with no underlying value that’s artificially driven up in price, and therefore almost guaranteed to crash. By kickstarting a meme stock’s rise, traders can hop in for cheap and cash out thousands of dollars richer (if they time their trades right).

But in the process, retail investors are often left in the dust, clutching worthless stocks in the hopes that the price will rise – or cashing out at a substantial loss.

So, why do retail investors buy into such volatile securities?

The answer appears to be, at least in part, FOMO: the fear of missing out.

Whereas the average retail investor rarely has the time, savvy, or funds to trade stocks regularly, jumping in and out of fast-rising, high-return meme stocks provides a chance to see their net worth increase exponentially, potentially overnight.

And for those who’ve seen a handful of successful (or lucky) individuals make millions on a single trade, the fear of missing out on this opportunity can be too much to bear.

The Meme Stock Cycle – and its Inherent Risks

It’s well-known that trading is a risky method of investing that generates high rewards only for the lucky few. But such risks are heightened in the meme stock trading cycle, which favors early traders to the detriment of average retail investors.

This unofficial cycle was outlined by one Redditor on the WallStreetBets forum as such:

  • Early Adopter Phase: This is when a handful of investors target a stock – either in good faith or with the intent of driving up the price to squeeze institutional investors – and purchase enough shares to drive the price up.
  • Middle Phase: During this transitory period, investors who’ve caught on to the increased stock price or volume jump aboard. As a result, the price begins to soar higher and faster.
  • FOMO Phase: When word of the rising tide spreads on social media and online forums, average retail investors who fear missing out on the next wave of successful meme stock trades pour in rapidly. The price skyrockets, sometimes in an afternoon.
  • Profit-Taking Phase: Early adopters and experienced traders predict that the end is nigh. They cash out, driving the price down. When other investors catch wind, the stock sees a mass exodus, leaving unlucky traders holding worthless positions.

In this cycle, the traders who get involved early and cash out first tend to be the most successful. Unfortunately, that doesn’t define the bulk of retail investors who participate in meme stock trades. In fact, most investors buy in during the FOMO phase, when the stock is nearing its zenith – and, assuming precedent holds, when it’s about to crash.

How to Invest in Meme Stocks

If you want to make your fortune in meme stocks, our advice is simple: don’t.

As a rule, it’s unwise to let FOMO dictate your investment strategy, no matter how lucrative meme stock trading may seem. There’s no way to estimate which stock will propel investors’ portfolios to unprecedented heights. And by the time the average person climbs on, it’s likely reached the “FOMO phase.”

But if you want to invest in meme stocks, there are a few steps you can take to, hopefully, minimize your risks:

  1. Understand that buying into low-quality, high-priced stocks come with a risk of losing your capital.
  2. Do your due diligence and choose the right company. Focus on stocks with competent, creative management teams that know how to exploit the hype, which may increase the underlying value of their business.
  3. Get in early – and get out when the stock starts to drop. (In other words, prepare an exit strategy and then stick to it.)

Additionally, it’s important to recognize that most successful meme stock investors are professionals, high-net worth individuals, or traders who buy on margin at exponentially increased risk. And while a few of them do make their fortune in the stock market, they are the exception – not the rule.

If you really want to see success in your investments, taking the long approach with a well-diversified portfolio is, statistically, a better path to success.

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