Are Meme Stocks a Smart Investment Choice?

Key Points

• A meme stock is a stock that gains significant popularity and price movement primarily due to social media hype, internet forums, and online communities rather than traditional financial or business fundamentals.
• Meme stocks saw soaring share prices during the early part of 2021.
• Most meme stocks had heavy levels of short interest, which resulted in parabolic short squeezes.
• Meme stocks benefited from easy money policies during the COVID-19 pandemic and are unlikely to regain their meteoric highs.

If you were an active trader during the early months of 2021, you could watch the meme stock rally unfold in real time. Investors and institutions will study the events of that time for decades as immense fortunes were made (and lost) in just a few weeks. While meme stocks are fizzling out today, it's important to understand how the craze came about and whether these companies are still worthy of our capital in the present day.

What Is a Meme Stock?

So what is a meme stock, exactly? And what is a meme stock rally? To borrow a quote from a famous Supreme Court justice, it's something you'll know when you see it. Meme stocks aren't a specific sector or stock type, but a loosely-tied group of securities paraded about by social media influencers, retail investors, and pot-stirring CEOs.

To understand meme stocks and pick the next meme stock, you'll need to understand the meme definition. In a broad sense, a meme is simply an imitation, such as an image or video spread around the internet. The name "meme stock" piggybacks on this viral nature as many traders flocked to these stocks due to repeated pushing on Reddit, Facebook, Twitter, TikTok, Instagram and other social media outlets. News of these stocks spread like wildfire throughout the internet, causing lots of dollars to flow in from various sources. 

Characteristics of Meme Stocks

Meme stocks exhibit several defining characteristics that differentiate them from traditional stocks, shaping the dynamics of their trading and investor sentiment. 

• Small Market Cap: Meme stocks are often companies with smaller market capitalizations. Viral trends can significantly impact stock prices when the float and market cap are small.

• Nostalgia Factor: Early meme stocks like GameStop Corp. NASDAQ: GME and AMC Entertainment Holdings Inc. NYSE: AMC were tied to feelings of nostalgia. Many traders had fond memories of these companies from their youth, which fueled their popularity.

• High Short Interest: Meme stock mania was driven by high short interest. Many retail traders saw hedge funds short selling as an attack on beloved businesses, creating an "us vs. them" mentality. This narrative spurred social media influencers to promote these stocks as a form of resistance.

• Complex Reality: Despite the narrative, many meme stocks were in financial trouble. While some hedge funds lost billions on short positions, others profited from the volatile movements, making the situation more complicated than it seemed.

How Social Media Influences Meme Stocks

Meme stocks tend to go viral just like your typical internet meme. In most cases, these viral stock trending instances stay confined to certain sections of social media, like finance people on Twitter or the WallStreetBets group on Reddit. Occasionally, a person with a large following can induce a viral craze that results in millions of dollars of altered market cap.

Tesla CEO and social media provocateur Elon Musk is one of those people. During the meme stock craze of 2021, Musk tweeted several times about GameStop and the meme-themed cryptocurrency Dogecoin, causing both prices to escalate after he published his tweets. 

However, "virality" works both ways, and memes often have short lifespans. Social media influencers can push meme stocks higher if enough eyeballs land on their posts, but the rallies usually dissipate as quickly as they start. And for those who entered these stocks at the end of the rally fray, the results were frequently disastrous. 

When Did Meme Stocks Start?

GameStop was the original meme stock, garnering significant attention on the WallStreetBets Reddit board. An investor named Keith Gill (known by his Reddit handle, which we can't print here) proposed a theory about the beaten-down game retailer, claiming the stock was so heavily shorted by institutions that a large short squeeze could occur. Gill accumulated shares and stock options beginning in 2019, sharing his insights and activities with the WallStreetBets board. 

In January 2021, former Chewy Inc. NASDAQ: CHWY CEO Ryan Cohen joined the GameStop board, which sparked the short squeeze. Hedge funds and retail investors piled into the stock, lowering the price and forcing short sellers to buy more shares to close out their positions. GameStop rocketed 1,500% in weeks, and several other heavily shorted stocks such as AMC, Blackberry Inc. NASDAQ: BB and Bed Bath and Beyond Inc. joined the action with their short squeezes. 

Meme stocks saw drastic price movements into Q2 of 2021, but the mania began to fade at that point, and many of these stocks crashed down hard from their peaks. For example, AMC reached a high of over $72 per share in May of 2021 but was back trading under $15 by the end of the year. 

Meme Stock Terms to Know

If you're diving into the world of meme stocks, there are a few key terms you'll need to understand. Here's a quick rundown of the most common meme stock lingo:

• Short Squeeze: When a heavily shorted stock rises sharply, forcing short sellers to buy back shares, driving the price even higher.
• Diamond Hands: A trader who holds onto a stock despite volatility, showing resilience and refusal to sell.
• Paper hands: A trader who sells too early due to fear of losses or market pressure.
• YOLO: "You Only Live Once" is used when making high-risk trades with the hope of massive rewards.
• Tendies: A slang term for profits made from stock trading, derived from "chicken tenders."
• HODL: An acronym for "Hold On for Dear Life," it means keeping stocks long-term regardless of market fluctuations.
• FUD: "Fear, Uncertainty, and Doubt" is used to describe attempts by media outlets, analysts, or other market players to discourage retail traders from holding certain stocks by spreading skepticism or pessimism.

Is the Meme Stock Craze Over?

While meme stocks still garner attention in certain social media circles, the days of extraordinary gains from stocks like GameStop and AMC are likely behind us. These companies were heavily shorted for a reason — many had declining revenues, outdated business models, or struggled to compete with newer, more innovative competitors. This was particularly true for meme stocks in the retail and entertainment sectors, like GameStop and AMC.

Though meme stocks remain volatile and can still offer quick profits with well-timed trades, the possibility of life-changing wealth from these stocks has significantly diminished. The massive short squeezes that drove the 2021 frenzy have faded, leaving behind struggling businesses and a core of loyal retail traders. So, if you're hoping to get rich quickly from meme stocks, you may be disappointed as the easy money has long been made. While certain stocks continue to trend on social media and attract financial news attention, the fervor has certainly died down. 

The viral meme stock trend of 2021 will undoubtedly be studied in business and economics courses for years. Today, meme stocks have become a form of high-risk gambling for traders seeking a thrill, but the likelihood of experiencing the explosive gains of the past is slim.

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