What Is a Meme Stock?

Posted by: Joseph Kuo | September 17, 2021

Taking the advice of complete strangers to get “in” on a stock purely based on popular acclaim is the antithesis of a sound investing strategy. But anyone watching the markets closely at the beginning of this year saw that certain stock prices soared overnight.

Until recently, the idea of getting your investment advice from social media or an anonymous internet forum like Reddit probably seemed ridiculous. Taking the advice of complete strangers to get “in” on a stock purely based on popular acclaim is the antithesis of a sound investing strategy.

But anyone watching the markets closely at the beginning of this year saw that certain stock prices soared overnight, and it wasn’t because these businesses had suddenly revamped their strategies and business models. All of a sudden, “meme stocks” could be found across every news outlet.

What Are Meme Stocks?

A meme stock (“meme” referring to an internet-edited image or other content that has gone viral) is a stock that has gone viral online and has attracted the attention of small and casual retail investors. These stocks are typically based more on hype than they are on the company’s actual valuation or performance. Instead, the value of these stocks increases because of anonymous forums like Reddit, where anyone can try and post content encouraging others to buy certain stocks. Or, social media outlets feature influencers who make short videos with everything from simple financial advice to stock recommendations. Unlike traditional financial information sites where authors disclose if they own a stock they are writing about, content creators on forums and social media content generally have no such requirements.

You’ll likely remember some of the meme stocks that trended and increased in value this year. These included Blackberry, AMC Theatres and GameStop. Even Tesla has achieved meme stock status based on the attention it received in the Reddit retail investor message boards.1

Meme Stocks vs. Traditional Investing

The CFA Institute specifically defines a meme stock as a stock that has gained prominence on Reddit’s WallstreetBets discussion board.1 Once a stock crosses a certain threshold, the CFA Institute notes the date and begins to track information about the stock and how it performs on the market.1

What makes meme stocks a questionable investment is their extreme volatility, and in most cases, the complete lack of reason or fundamentals other than the whims of the internet. The average volatility of these stocks before they became memes (“pre-meme”) was 83 percent.1 Once the stocks reached meme status (“post-meme”), their volatility jumped to an average of 106 percent.

The Meme Stock Cycle

Unlike long-term investment strategies, meme stocks operate on a more volatile cycle. Meme stocks tend to follow a similar pattern:

  1. Early adopter
  2. Middle phase
  3. Late/FOMO phase
  4. Profit-taking phase

Early Adoption

In this phase, a handful of investors have identified a stock that they want to pump up. The criteria could vary: this could be an undervalued stock or a well-known company with wide public recognition. These investors start buying this stock in large quantities and then start publicly touting the stock. They could also do the opposite and short a stock and try to drive its price down. Early adopters and “influencers” tend to be the ones who benefit the most as they get in on the ground floor.

Popularity Rises

As these investors begin buying stocks in large quantities, ideally their posts on the internet or social media start to gain traction, getting more individuals to take notice and start to pay attention. People who see the social media or forum posts are influenced to start buying the stock and its price begins to increase.

FOMO Phase

The stock goes “viral” as word spreads widely to other forums and social networks and even financial news outlets. More retail investors join in the buying phase, driving the stock price up further. FOMO means “fear of missing out,” so at this point many retail investors are jumping in when stock prices are already high.

Profit-Taking Phase

After a few days, the  early adopters and influencers start cashing out. This starts a chain reaction, driving stock prices back towards their starting price. Anyone didn’t cash out is now left deep underwater.

Key Takeaways of Meme Stocks

One of the positives of recent meme stock sensations is that it brought investing to the mainstream conversation. Now more than ever, people are talking about the stock market and educating themselves about investing.

If you’re considering jumping on the next trending stock, be aware that with these stocks, the companies are not trending due to actual potential or fundamentals. Instead, the choice often boils down to timing and being a well-known name. Sometimes, a poorly performing company (Blackberry was a recent example) might be chosen purely as a contrarian gesture.

If the meme stock cycle sounds like “pump and dump” to you, yes, it’s basically a modern version of that technique, adapted for the social media era.  While the prospect of a potentially huge gain in a short time span can be tantalizing, studies show that even the most experienced day traders lose money when they invest. Novice investors who bought or shorted meme stocks risk losing large amounts of money if they mistimed the wave. The high amount of risk in meme stocks is not unlike gambling. In short, definitely consult with an experienced short term investor or financial advisor, and don’t risk money you wouldn’t mind losing.

In most cases, it’s more beneficial to focus on your personal financial goals over the long-run than get caught up in short-lived investment trends. Instead of looking for the next hot stock tip, consider your risk tolerance, time horizon and goals. Work with your financial professional to determine if investing in a meme stock should be part of your portfolio, or if you’re better off sticking to a long-term investing strategy that will be able to weather normal market volatility.

Want sound investment advice? Contact me by email at joseph@abundancewp.com, or schedule a meeting by clicking the button below:

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