What are Meme Stocks?
You’ve heard about them online, you’ve maybe heard about them from friends, and you still might be wondering: What are meme stocks?
A meme stock is a stock that has gained a large following online through communities like r/wallstreetbets on Reddit.
These online communities, like Reddit, build up hype around a stock through communicating with others online. These communities can have a huge impact around a stock and can make prices for these stocks increase in value fast. The success of a stock doesn’t have anything, really, to do with how well the company is performing.
Now, when everyday investors, or small investors, also known as people who invest in a small quantity of stocks and bonds, pile in on a meme stock, its value rises for a while, and people can often profit from this move.
How Do Meme Stocks Work?
Before we get to discussing how meme stocks work, let’s start in 2020 with a video game retailer named GameStop (NYSE:GME), one of the first meme stocks.
People on Reddit noticed that big hedge funds mostly held short positions, and these funds would have to cover their position in the event of this stock being driven higher by a short squeeze. Basically, Wall Street investors were shorting GameStop stocks for profit.
For example, let’s imagine one such Wall Street investor named John.
He was betting on GameStop plummeting in value. Now, while investors usually count on profiting from a stock price going up, short-sellers like John hope to profit when things go down.
In January 2021, small investors on Reddit got tired of people like John.
So they organized a short squeeze, where they started buying up GameStop stocks rapidly. This action made GameStop stocks go viral.
The result?
The small investors on Reddit caused sent GameStop stocks up quickly from $17 to $500 a share. This number is almost 30 times its original value.
With this situation in mind, what happens to John and other short-sellers who only profit when GameStop drops?
Well, they’d have to sell to stop losing more money. By these people short-selling stocks, they pushed GameStop prices up even further.
This is just an example of a situation (from a meme stock) where the small investor was rewarded over the Wall Street elite.
Want to know more about the GameStop short squeeze?
check out this book, it explains how r/WallStreetBets took down some of the greatest hedge funds on Wall Street.
Advantages of Trading Meme Stocks
As you’ve seen earlier, you can make a lot of money from trading meme stocks in a very short amount of time, and there are several advantages from trading meme stocks.
One of the advantages of trading meme stocks is that you might be helping to
raise a company’s stock prices. You could be renewing consumer interest in their company as well as injecting fresh capital to revive a failing business.
Additionally, the rise of meme stocks has helped a younger generation become educated about investing and trading through these social media fads. Although it’s not clear right now on whether meme stocks will help young traders gain long-term financial habits like saving for retirement.
Finally, small investors have proved that Wall Street elites should take them seriously.
Disadvantages of Trading Meme Stocks
One of the big disadvantages of trading meme stocks is that you can never predict what’s really going to happen with trading meme stocks. Just remember: It’s impossible to time the market.
Here’s an example from 2021 about how you really can’t anticipate what will happen in the market:
When retail investment platform Robinhood suddenly started heavily regulating meme stock purchases, GameStop stocks dropped sharply from $500 to $40. There was no way anyone could predict this regulation happening ahead of time
Another disadvantage of trading meme stocks is that it is extremely high-risk investment and a volatile one, too. Moments where stocks skyrocket are generally only temporary.
Do you have the stomach (and money) for that much risk?
[Have you been wondering if you’re investing or saving enough for retirement? Check here.]
While people traditionally trade stocks based on the health and performance of a business, the value of your meme stocks relies mainly on the whims of what people are saying on social media, which is a force that can turn at any time.
Investing Considerations
Hopefully you have enough information to understand what meme stocks are so that you can make informed decisions for your portfolio.
However, if you’re wondering how to invest in meme stocks, there are a few things you need to consider. Most importantly, remember that by the time you’ve heard of a meme stock in mainstream media it’s probably too late to buy it. As with any kind of investment, you need to weigh the pros and cons before you get started.
If you’re looking to invest in stocks, consider investing in a wider variety of stocks and ETFs. It’s never a good idea to have your entire portfolio in a few stocks. And, as always, think about the risks before you do place a trade.
Additionally, you need to think about whether you have enough money set aside for necessities, a rainy-day fund, debts, retirement, and capital gains tax.
As we said earlier, you can never time the market, but if you weigh the pros and cons of what works for you and your financial goals, you should be well on your way to meeting them.