What are meme stocks?

Meme stocks are highly volatile shares that gain widespread attention, particularly among retail traders, through online platforms like Reddit's r/WallStreetBets. These stocks often experience extreme price surges driven by social media hype and motivated retail traders.

The rise of meme stocks reached its peak during the COVID-19 pandemic when retail traders, using social media as a tool for collaboration, fueled the dramatic surge of GameStop (GME) shares. This rally targeted a stock that had been heavily shorted by hedge funds, betting on its decline. 

The resulting short squeeze caused massive financial losses, totaling $19.75 billion in January 2021 alone. Melvin Capital, one of the hardest-hit hedge funds, saw a 49% drop in its portfolio and required a $3 billion bailout to stay afloat.

This phenomenon demonstrates the power of a large group of retail traders who can challenge the traditional dynamics of Wall Street when united by a shared goal.

In this article, we’ll delve into what meme stocks are, how they gain momentum, and why they capture the attention of investors.

A meme stock refers to the shares of any company that has become popular among retail traders, often leading to volatile price action. This popularity typically emerges from a prevailing narrative repeatedly shared on social media platforms such as X, Reddit, TikTok, YouTube and LinkedIn. 

Adapted from Britannica’s definition, meme stocks have the following characteristics: 

1. Social media plays a significant role in generating interest. 
2. The price action connected to meme stocks is often highly volatile, with wild shifts in volume.
3. The majority of interest comes from retail traders, rather than hedge funds or asset managers. 
4. Prices are disconnected from company fundamentals, such as how much the company is earning or other performance metrics.

For a stock to become a meme stock, it needs a viral story that creates a passionate following. This excitement often encourages many retail traders to jump in.

Meme stocks become popular when their story connects with everyday investors. Research on retail traders in the WallStreetBets community suggests that many feel they are falling behind financially and see meme stocks as a chance to make quick profits—even if it means taking big risks.

A notable example that is often cited is GameStop. Many small investors saw it as a way to fight back against Wall Street. Hedge funds had heavily shorted GameStop’s stock (betting its price would fall), so retail traders pushed the price up to apply pressure and cause losses for these big institutions.

In a way, meme stocks can be seen as a battle between everyday people and powerful financial players, much like David vs. Goliath.

Social media plays a critical role in meme stocks by:

• Creating a sense of belonging, united by a common goal.
• Proliferating a persuasive and viral narrative.
• Coordinating the behaviour of a herd of investors to act in unison.

The case of the Game Stop short squeeze provides a useful example of the role that social media plays. The following provides a breakdown of the sequential events that led to the meteoric rise in the price of the GME stock:

1. August 2020: Redditor Keith Gill aka ‘Roaring Kitty/DFV’’ posts a video on YouTube detailing Gamestop’s plans to revitalise the company while also highlighting the notably high short interest. In actual fact, more shares were shorted than ever existed (140% of total shares). The price of GME at the close of August 2020 was $1.67. 
2. September 2020: Ryan Cohen (Chewy co-founder) buys a large stake in GameStop, signaling a possible turnaround. The WallStreetBets (WSB) community on Reddit starts paying more attention, and Roaring Kitty’s GME sizeable bet looks more reasonable. GME closed higher in September, at $2.55. 
3. December 2020: WSB starts widely circulating the "Mother of All Short Squeezes" (MOASS) theory—if retail traders buy and hold, hedge funds will be forced to cover at any price. Once again the price of GME inched higher, close to $5. 
4. January 2021: The short squeeze begins in full force, forcing hedge funds like Melvin Capital to take emergency funding. GME’s price starts accelerating rapidly, going from $4.75 at the beginning of January to closing at over $80, reaching an all time high of $120. Elon Musk tweets ‘Gamestonk!!’ in reference to GME.
5. May 2024: After trading down to a low of around $10 in May 2024, GME experienced another short squeeze after Roaring Kitty shared a meme of someone sitting forward in their chair (‘lock in’). While it’s impossible to be certain of causality, the following day, the price of GME rose by over 100% to $65. At press time, it is currently trading around $27. 

Other top meme stocks from recent history include:

• AMC Entertainment (AMC)
• Blackberry (BB)
• Bed Bath & Beyond (BBBY)
• Koss Corp (KOSS)
• Vinco Ventures (BBIG)
• Tesla (TSLA)

Investing in meme stocks comes with a host of associated risks that traders need to take into consideration before investing any capital.

Meme stocks tend to be extremely volatile, and can lose large chunks of their value overnight. Therefore, exercising responsible risk management when considering buying them is often advised, as the possibility of losing all of your capital is a very real threat. Many of the meme stocks that skyrocketed in 2021 have experienced significant drops in price.

The price of meme stocks is to some degree a reflection of the stocks prevailing popularity and strength of the narrative. If the virality of the meme starts to fade, then investor interest may also fade, resulting in many selling the stock. Some traders find it useful to pay close attention to what others are saying in the relevant circles and social media platforms.

It's important to recognize that meme stock prices can become disconnected from their underlying fundamentals. As a result, these stocks can experience rapid price fluctuations, especially when the initial wave of bullish sentiment fades. Investors should be aware that once the hype subsides, meme stocks may face swift and significant repricing.

Operating as part of a group of investors certainly has benefits, but also arguably increases the likelihood of being influenced by others and failing to exercise rational and objective judgement.

Because of the highly volatile nature of meme stocks, there is also the possibility that regulators may intervene in a way that severely dampens investor sentiment. 

Trading platforms can also add to the overall risk profile. Robinhood famously restricted purchases of GameStop shares, citing volatility, leading to widespread criticism and discussions about market fairness.

Meme stocks can offer opportunities for investors, but it is important to understand that they come with significant risks, and the past performance of some successful stocks is not indicative of how other emerging meme stocks will perform. Investors should carefully consider these risks before engaging in any trading activity.

One of the primary attractions of meme stocks is their potential for significant short-term gains due to extreme price fluctuations. However, these price swings can be unpredictable, and investors should be aware that they may also experience substantial losses. As with any investment, there is no guarantee of profit, and investors should conduct thorough research and exercise caution.

Meme stocks have also demonstrated that retail traders can influence market movements, challenging traditional institutional investors. This has contributed to a shift in market dynamics, where individual traders can play an important role in driving price action.

Investing in meme stocks can create a sense of community among participants, as traders often share experiences and opinions on social media and other platforms. While this sense of belonging can be engaging, it is important to remember that collective sentiment can lead to extreme price movements, which can be both positive and negative.

Additionally, meme stocks have introduced many individuals to the stock market, prompting interest in broader financial education and investment opportunities. While this can be a positive outcome, new investors should seek professional advice and ensure they fully understand the risks involved in stock market trading before participating.

As with any investment, it is crucial that individuals carefully assess their financial goals, risk tolerance and level of experience before making any investment decisions. Investors are encouraged to seek independent financial advice and avoid making decisions based solely on short-term market trends or social media discussions.

Meme stocks represent a fascinating intersection of investing, social media and retail investor activism. While they offer the potential for substantial short-term gains, they also carry significant risks due to extreme volatility, market unpredictability and regulatory concerns. 

Investors interested in meme stocks should approach them with caution, conduct thorough research and be prepared for the possibility of losses. Understanding the dynamics of online communities, market trends and the role of speculation is crucial for anyone looking to navigate this unpredictable investment landscape.

Ultimately, meme stocks are a testament to the power of retail investors and the influence of digital communities. Whether they remain a long-term market force or fade as a passing trend, their impact on investing lore is undeniable.

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