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What you need to know about meme stocks
The excitement to make a large amount of money in a short period of time can be enormously tempting – therefore, investors may sometimes resort to meme stocks, succumbing to that temptation.
Before you make like an ape and go bananas, here's what you should know.
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Meme stocks have become quite popular in the last few years. During the COVID-19 pandemic, some traders started talking up stocks on social media sites such as Reddit. The excitement potentially urged many other people to buy and/or sell based on those talking up a particular meme investment.
If you are considering investing in a meme stock, it can be wise to:
- Do your due diligence to ensure it is indeed a good pick that aligns with your investment goals
- Have a strategy, whether you’re buying and quickly flipping the stock or hanging on
- Although you may see the potential for a quick gain, you may not want to invest more than you can afford to lose, because you can lose a lot and fast
What is a meme stock?
A meme stock is essentially a stock that’s gone viral. Just as a funny photo or video can get passed around the internet for all to see, so can a meme stock. The word "meme" refers to ideas or images that spread exponentially on the internet. The big difference is that receiving a ridiculous picture from a friend is free, while buying a stock position based on a recommendation from an anonymous person online can be costly.
Meme stocks tend to be the subject of discussion on social media platforms such as Reddit or Twitter, which can lead to cult-like loyalty from retail investors and a massive jump in trading volume and price movements. The discussion is rarely focused on the fundamental attributes of the company. In some cases, as can be seen from the history of meme stocks, it can even be a punitive attempt to “squeeze” professional investors who have sold the stock short to cover their positions.
History of meme stocks
The first widely acknowledged meme stock was GameStop Corp. (NYSE:GME). When the flagging electronics retailer became a target of short sellers in 2020, participants in the Reddit forum r/wallstreetbets organized a viral campaign during which thousands of small investors bought the stock, sending its price up more than 100-fold at its peak. Some of the investors behind the scheme had substantial holdings, so they had a material interest in hyping it for personal gain.
The effort succeeded in forcing the short sellers to repurchase the stock at hugely inflated prices to cover their positions, which both supported GME’s price and, in a number of cases, put the short sellers out of business. The retailer’s share price eventually dropped, causing many participants in the campaign to lose money.
How to trade in meme stocks
Meme stocks can be bought and sold using an online brokerage account, just like any other stock. Because many meme stocks to date have traded exclusively on U.S. exchanges, Canadian investors may incur higher trading fees than they would for companies trading in Canada.
Meme investing glossary
Meme stock fanatics have created a whole lexicon to describe their hobby and the community around it. Here are some of the terms they have used to talk about meme stock investing:
Apes: Self-described members of the meme stock community (initially derived from “AMC apes” around the time an instalment of Planet of the Apes was playing in theatres)
Diamond hands: A term of respect for investors who hold onto a stock despite big losses
FOMO: An acronym for “fear of missing out” that is widely considered to be part of the motivation for participating in meme stock action
Hold the line: An admonition to keep holding a meme stock in the face of volatility
Paper hands: A derogatory term for investors who sell meme stocks to avoid further losses
Stonks: Ape-talk for stocks
Tendies: Capital gains made on meme stocks (a derivative of fried chicken tenders)
To the moon: Where investors think the next meme stock is headed, in theory, always resulting in big gains
YOLO: Short for “you only live once,” an oft-used rationale for buying a meme stock
We like the stock: Expression used on Reddit to endorse an equity, often accompanied by the rocket ship emoji
Bagholder: An investor who holds onto a stock as it declines toward zero in the hope of a turnaround
DD: Short for “due diligence,” which may mean something different to apes than to other investors
BANG: A play on “FAANG” technology stocks, BANG refers to meme stocks: BlackBerry, AMC, Nokia and GameStop
ATH: Short for “all-time high,” the stock’s peak market price
Why investors consider meme stocks
There may be a few reasons why investors have jumped onto the meme stock craze. The first is that many hope to make a large amount of money in a short period of time.
The other reason why people buy in can simply be: It’s fun to join the crowd. Similar to jumping on a bandwagon when a sports team makes it to the finals — many people enjoy taking part in the excitement. In the case of meme stocks there may be no better bandwagon than joining the social media masses. Ultimately, there may be nothing wrong with having a little fun if you have the extra money to spend. Using retirement or money allocated for reasons other than investing to play the meme, however, could be more dangerous.
What are some risks associated with meme stocks?
The biggest risk with a meme stock is losing all of your money. Without solid fundamentals to back up the price increase — such as increasing revenues or profit growth — sustaining excitement for a company can be difficult after the initial wave of exuberance subsides. Stock prices of meme stocks tend to plummet as soon as sentiment turns.
Because price gains are driven by what the masses think and not by fundamentals or core value meme stocks have shown to be highly volatile. After their initial run-up in price, some return to the levels they traded at before they went viral. Others continue to fluctuate in a range between their peak and previous levels. Retail investors who bought meme stocks on their way up may have been left with shares that now trade below the price they were purchased at.
Key factors to consider before investing in meme stocks
Before buying into a meme stock, it can be important to review the company’s fundamentals and make a case for investing. Just like you wouldn't buy a company simply because a colleague told you they have a hot stock tip, you may not want to follow the crowd into a business that could go bust. Look at annual and quarterly reports to see whether the company is growing. Are revenues rising? Is the company increasing earnings year after year? Does it have a product lineup that makes sense to you? Research other fundamentals to see how the meme stock may add value to your portfolio. Analyst reports often list price targets — take a look at those to see what pricing level the professionals recommend. If you want to jump in, it may be a good idea consider if the price is sustainable.
Frequently asked questions
What is considered a meme stock?
A company that’s seen a huge increase in price because a mass of internet users have decided to buy the business all at once may be described as a meme stock. In many cases, the company's fundamental values can be disconnected from their viral popularity.
Should I invest in meme stocks?
Meme stocks are not inherently bad companies, but the price could be getting ahead of the fundamentals. It may be wise to ensure you have an awareness of the business before buying in and that you are investing with dollars you can afford in the event the price movement is not in your favor.
What is the meme stock boom?
The meme stock boom started in January 2021 amid COVID-19 pandemic lockdowns. That’s when internet users identified several inexpensive stocks to purchase many of which were held by short sellers who were betting on equity price declines. The more people who talked about these companies online, the more investors bought in, pushing prices higher.
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