What Are Meme Stocks?

Mon May 23, 2022, 02:13 pm | by Dan Schmidt | No comments

Before we get too far: you just clicked on an article about meme stocks. There’s going to be discussion about GameStop, Reddit, Dogecoin, and maybe even that guy from Barstool Sports. Still want to keep going? Good, just remember, you were warned.

These so-called “meme stocks” gained national fame back in January when GameStop (NSDQ: GME), AMC Theaters (NYSE: AMC), and a host of other less-than-reputable companies began making parabolic moves upward in the market. So what makes a company into a ‘meme stock’ and how should investors proceed moving forward? That’s what we’re going to take a look at today.

What is a Meme Stock? 

If you replace the word ‘meme’ with ‘hype,’ you might get a more clear definition. Meme stocks began garnering popularity in late 2020 when a Reddit trader named Keith Gill (you may know him better as Roaring Kitty on Twitter) began discussing a large bet he was making on video game retailer GameStop. 

The thesis behind the trade was twofold. First, the company was actually in a much better financial position than Wall Street analysts had previously claimed and Gill liked the turnaround potential. Second, the stock was the most shorted security on the market and any quick bump in price would cause a massive short squeeze.

Gill began accumulating both shares and call options on GameStop throughout 2020 and the trade exploded in the middle of January. GME shares were trading below $20 in December but soon rocketed to over $450 by the end of January. By then, other heavily shorted stocks like AMC Theaters, Bed Bath and Beyond, Express, and BlackBerry were also getting squeezed. Following that, Ja Rule was on CNBC discussing Robinhood, and Barstool Sports’ Dave Portnoy was recording day trading videos. Yes, the top arrived shortly thereafter and GameStop crumbled more than 50% off the high.

What the meme stocks all had in common was the high level of short interest in their shares. Companies like GameStop, AMC, and BlackBerry were some of the most hated on Wall Street due to their poor sales data, lack of growth, and inability to innovate from past success. While Gill professed that GameStop was actually in decent shape if you looked at sales data, most of the meme stocks were performing poorly and hedge funds shorted them relentlessly. 

Examples of Meme Stocks 

  • GameStop (NSDQ: GME) – The original meme stock that exploded thanks to the Wall Street Bets forum on Reddit.
  • AMC Theaters (NYSE: AMC) – Another heavily-shorted stock that went parabolic. With theaters being closed due to the pandemic and lockdown restrictions, short interest in the company skyrocketed.
  • BlackBerry (NYSE: BB) – Having long given up smartphone dominance to Apple and Android, BlackBerry was another stock with heavy short interest that Reddit traders piled into.
  • Bed Bath and Beyond (NYSE: BBBY) – Brick and mortar retailers were a popular choice to short amongst hedge funds.
  • DogeCoin – So this one isn’t a stock, but it was literally meme’d into prominence by Tesla CEO Elon Musk, who caused a pop in the joke crypto’s price with every tweet.

What Causes a Meme Stock to Move? 

The beginning of most meme stock ideas comes from the Wall Street Bets (WSB) forum on Reddit, which saw tremendous user growth during the early stages of 2021. WSB users are often Robinhood traders with savvy financial skills.

Meme stocks move based on social sentiment on forums like Wall Street Bets or social media platforms like Twitter, Facebook, or Tik Tok. No fundamental analysis applies and very little technical analysis is used either. Meme stocks jump based on viral posts and videos, which make them the perfect vehicle for day trading. Meme stocks traders often use far out-of-the-money (OTM) call options to increase leverage and score major profits when the stock gets pumped. Calls which would’ve seemed impossible suddenly become reality.

Precautions to Take When Trading Meme Stocks 

Meme stocks traders are (unwittingly) proponents of the Greater Fool Theory in finance. When taking a position in a stock like GameStop or crypto like DogeCoin, the end goal is simply to pass the security on to a more gullible party after the profits have been made. They know they’re buying a company with poor fundamentals or a bad reputation, but hope to sell before the music stops.

Trading meme stocks requires an extra level of precautions, like trading inverse or leveraged ETNs. Viral social media posts or videos are often all the catalyst a meme stocks needs to make a large move. And just because a tweet or Tik Tok goes viral doesn’t mean the information contained in it is valid or actionable. It’s social media – anyone can make up anything about a stock in order to pump its value.

GameStop is a true cautionary example because by the time CNBC started discussing it on air, the profitability stage had already passed. In fact, GameStop reached it’s intraday high almost exactly at the moment CNBC had Ja Rule on to discuss Robinhood and meme stock trading. If you’re finding out about a meme stock from the news, it’s likely too late to make money off it.

Meme stock trading is like trading any other type of volatile asset: have a plan for trading it, but keep your stop loss orders engaged and always monitor volume and technical patterns. Moreover, make sure you know how your trading platform operates: the infamous Robinhood incident where trading was halted due to volatility concerns which caused people to question the integrity of the platform. In addition, “Stocks only go up!” might have been the early mantra of the meme stock traders, but that platitude has been proven false many times this season. 

Final Thoughts 

Meme stocks began as a fun little experiment amongst retail traders and ended with a large hedge fund called Melvin Capital needing a massive capital infusion to stay afloat. While many of the early adopters were rewarded with incredible gains, many retail traders who jumped on the wagon due to FOMO at the end of January were left holding the bag when the meme stocks predictably cratered. Even veterans of finance like Mark Cuban, Elon Musk, and Chamath Palihapitiya encouraged retail traders to jump into meme stocks right as the wave was cresting. 

GameStop remains down more than 45% off it’s highs as of this past year. The meme stock rally has fizzled now that the country is beginning to reopen and economic data improves. But history has shown that meme stocks don’t really need much of a catalyst to go bonkers and the original GameStop meme investor Keith Gill is still holding firm on his position. Those who are buying and “diamond handing” meme stocks, just understand what you’re getting into when trading – social media celebrities call the shots here, not Wall Street analysts or sophisticated institutional traders.