The rise of meme stocks

Yimin Huang | July 26th, 2022

Source: Mercurius Betting Intelligence

Introduction

A meme stock is a stock that gains popularity among retail investors through social media, and is generally based on internet memes shared among traders on platforms such as Reddit. The rise of meme stocks in recent years is in part due to increasing awareness among the public about retail investing. Now, It is easier than ever to enter the market, meaning more people can contribute to the price surges of these meme stocks.

Like other high-volatility assets, meme stocks pose huge potential risks as they are reliant solely on investor sentiment without any basis in business fundamentals. They are highly volatile with sharp, unexpected price changes due to rapid changes in supply and demand, and are short-lived, as with most trends that gain traction on social media.

Source: Bloomberg

Cycles of a meme stock

A meme stock cycle typically goes through the following stages:

Early Adopter / Stealth Phase: A number of investors think that a particular stock is undervalued and begin to buy it up in large amounts. The stock’s price slowly begins to increase.
Growth / Awareness Phase: The stock starts to take off and increases in popularity. People who were already watching the market and had a close eye on these stocks started noticing the increase in volume. More people stake their claim, and the stock’s price rises further.
Mania / Maturity Phase: Word about the stock spreads across social media and online forums and reaches peak popularity. Thus, fear of missing out takes hold, and more retail investors (i.e. the public) join in. At this stage, the price of the stock shoots up massively in a short period of time as it goes from attracting media attention to feeding on the enthusiasm which snowballs into irrationality as some retail investors become driven by greed and delusion.

Decline / Blow-off Phase: After a few days, buying peaks, and the people who got in the game early on begin cashing out. Just like the maniac buying phase, this selling phase induces a domino effect whereby as more people fear losing their gains, more sell their stock, which becomes a chain reaction and the stock price plummets.

Because of this cycle, it is the early adopters, investors who have insider information into the stock’s performance, who really profit from these trending stocks. Once word starts going around the public, it has already entered into the mania/maturity phase and is most likely too late to make a profit.

Examples of meme stocks include GameStop, AMC, and BlackBerry. While each of these companies’ financial performance had not been favorable in the past few years, all three stocks saw massive price hikes in early 2021, specifically on January 27. BlackBerry’s stock more than tripled to hit a nine-year high at $25.10 per share (Yahoo Finance), while AMC’s shares nearly quadrupled (CNBC). But neither beat the viral growth of GameStop, which is perhaps the most publicized meme stock after Reddit users began buying GME upon learning that two hedge funds, Citron Capital and Melvin Capital, had shorted the stock.

What is shorting a stock?

Shorting stock, also known as short selling, is when an investor — often an institutional investor like a hedge fund — borrows a stock and sells the shares with a plan to buy it back later to return. The investor does not own the stock, but is instead betting on the stock price going down between the time when they sell the stock to the market and when they repurchase the stock. This is a popular trading technique and has the potential to generate significant profits, but also runs the risk of losing a lot of money as it rests solely on a gamble on the stock price.

The rise of meme stocks is seen as a David versus Goliath moment, where amateur traders take on Wall Street’s professional money managers and sophisticated investors that had bet the Gamestop’s shares would fall, instead pushing up GameStop’s market value from $2 billion to over $24 billion within days, with shares rising over 1,700 percent from December 2020 (The New York Times).

Source: VICE

Conclusion

While certain meme stocks have indeed turned some investors into millionaires, it is still ultimately dependent on the traction it garners without any basis on the company’s fundamentals, and it is highly unlikely for the everyday retail investor to strike it big just by following the crowd. The rise of meme stocks should also be viewed in the context of the pandemic, where many investors were driven by boredom and the inability to spend their discretionary income on other leisure or recreational activities. Given the reopening of many economies in 2022 and the global economy facing rising inflation pressures, the focus is likely to shift towards hedging against inflation, with meme stocks taking a backseat.