If you are an active follower of stock market news, you’ve probably come across the term meme stock. And you may be wondering why this term is gathering attention recently.
A mem stock is a stock that has gone viral online, drawing the attention of retail investors. Meme stocks have become increasingly popular as of late. For the past week, the term made media headlines as a result of the popular meme stock GameStop (NYSE: GME) skyrocketing in price in a David vs. Goliath-like narrative. And while these meme stocks might make for an interesting news story, they actually tend to have more far-reaching implications for the average investors.
One deciding feature of a meme stock is that it has a trading volume increase not because of the company’s performance, but rather because of hype on social media and online forums like Reddit. For this reason, from a traditional investment point of view, these stocks often become overvalued, seeing drastic price increases in just a short amount of time.
Besides GME, AME and BlackBerry can also be classified as meme stocks. While the companies themselves have not performed well in recent years, all 3 stocks went viral on a popular Reddit forum and saw massive price increases in late January 2021, specifically Jan 27, BlackBerry’s stock more than tripled, while AMC increased by nearly tenfold. But neither saw the virality of GameStop, which increased by hundreds of dollars in a matter of days.
How does a meme stock work?
Simply put, meme stocks rise in popularity because of conversations held online. Due to the internet virality, they tend to see rapid price spikes. Because the increased price is artificial and not the result of the company’s actual performance, these spikes are usually followed by an inevitable crash.
These spikes have recently been fueled by a forum on Reddit called WallStreetBets. In a particular thread on the WallStreetBets subreddit, one user explained the meme stock cycle as follows:
- Early adopter phase: a handful of investors believe a particular stock is undervalued and begin to buy in large quantities. The stock’s price slowly begins to increase.
- Middle phase: people who are paying attention begin to notice the increase in volume. More individuals then start buying, and the stock’s price skyrockets.
- Late/FOMO phase: word about the stock spreads across social media and online forums, thuse, fear of missing out – commonly referred to as FOMO – takes hold, and more retail investors join in.
- Profit taking phase: after a few days, buying peaks and the early adopters begin cashing out. Just like the buying phase, the selling phase becomes a chain reaction as people fear losing money. This is where the price goes down.
Because of this cycle, it’s the early adopters who really profit from these trending stocks. Once the meme stock cycle enters into the FOMO phase, it’s likely too late to make a profit.
Recent trend of meme stocks
As cryptocurrency prices wilt, a new wave of meme stocking pricing surging is happening. Professional analysts say the rerun shows that the amateur fascination with markets can outlast the social curbs brought in last year to control the coronavirus pandemic. Some now see it as a more durable trend that is having a noticeable effect on the investment landscape.
At the end of May, Bitcoin and ether – two of the most popular digital coins – have plunged since early. As the air came out of that market, it appeared to be pumped right back into shares with intense retail interest. As the following chart shows (source: FinanceTime), the AMC is experiencing another surge as Bitcoin price falls.
A Goldman Sachs index of the stocks most often mentioned on the popular WallStreetBets Reddit page – which has become an online watering hole for day traders and some big money managers – has gained 20% this week, according to the bank.
This new meme stocks trend is viewed by some as the start of a new and important force in investing. While a lot of people try to say that this isn’t a good way to trade, there is no denying that the meme stocks is a new way for people to think about investing.