02 Aug INTRODUCTION TO MEME STOCKS

Posted at 12:41h in Expat, Expat Financial Advice, Financial Planning, Insight, Investment by Global Financial Consultants

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If you’ve been following the financial news this year, you’ve most certainly heard of a ‘meme stock’. Meme stocks out of the U.S. stock exchanges have taken the financial markets by storm in early 2021.

A meme stock is one that attributes an increase in its value primarily fueled by social media attention, and not its company performance and fundamentals. Meme stocks are often stocks with significantly high short interest that can be artificially manipulated to prove a point. The support of these ‘retail’ investors has captured the market trend in recent months, as huge volumes of trades were effectively sourced from social media chat rooms.

Chasing after meme stocks is not the safest financial strategy. Generally, these stocks are significantly overpriced in comparison to their intrinsic value. This often results in changes in their valuations and peaks of rapid moves within a short period of time. As a result, most institutional investors view meme stocks as risky speculative plays.

In the current state of the stock market, rising inflation risks have been affecting growth stocks. Hence, investors on the more adventurous spectrum may be willing to consider delving into these hype-fueled meme stocks. Learning about the phenomenon of meme stocks can help you understand the possibility of benefitting from its short-term volatility as well as the risks it introduces to the stock market.

What has Given Rise to the Popularity of Meme Stocks?

Increase in popularity of day trading as a consequence of the pandemic.
Discount brokerages offering commission-free trading, such as Robinhood and Webull.
Increasing discussion and attention on social media sites such as Reddit, Instagram, Twitter, and YouTube
Technology that makes it easy to transact and trade easily anywhere on a mobile phone.
A new generation of young traders.
Newly injected investor confidence with U.S. equity markets hovering near all-time highs, there has been an aura of newly injected investor confidence.
A number of unknown stocks have drawn the attention of retail investors since they trade in the sub-$5 range. Due to the ‘low barriers to entry, these stocks have seen their valuation explode this year due to retail interest.

What are Some of the Meme Stocks?

How Does a Meme Stock Work?

Meme stocks tend to see a rapid spike in their prices that can be attributed to a rise in popularity due to internet virality from conversations held online. As the increase in price is ‘artificial’, and not a result of the company’s operations and performance, very often these spikes are usually followed by an inevitable crash.

One user on the infamous subreddit ‘/r/WallStreetBets’ explains the meme stock cycle to be 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 to begin to notice the increase in volume. As a result of which, more individuals start buying, and the stock’s price skyrockets.
Late / ‘Fear of Missing Out (FOMO) Phase: Word about the stock spreads across social media and online forums. Therefore, the fear of missing out kicks in, and more retail investors join in.
Profit Taking Phase: After a few days, buying peaks, and the early adopters begin to cash out. Similar to the buying phase, the selling phase is a chain reaction of investors fearing losing their money. This is where the price goes down, often drastically.

Sources of Meme Stock Information

Meme stocks are built on the premise that sees its value increase fueled primarily by popularity and hype. Therefore, it is critical to keep a regular lookout for chatter in these areas that could signify a movement in market trends. For instance, financial institutions such as Bank of America identify the potential up-and-coming /r/WallStreetBets targets by analyzing for clients how many mentions each stock gets on Reddit, among other things like short interest.

These are just some of the very few platforms to keep a regular lookout on as they regularly reveal a plethora of synchronized communications amongst meme stock traders.

Terminology of Meme Pages

Meme pages are reputed for having their own arcane language, many of which will be unfamiliar to most people. Here’s a look at some of the phraseology widely used on /r/WallStreetBets.

Importance of Short Interest

As mentioned earlier, meme stock traders have been grouping up together to artificially manipulate stock prices of heavy-short interest to prove a point. Therefore, short interest is a significant indication tool when dealing with meme stocks.

The number of shares that have been sold short but have not yet been covered or closed out is known as short interest. Hedge funds and other financial institutions use exorbitantly big short interest holdings on certain equities to indicate their bearish and pessimistic investment sentiment.

Short interest can provide insight into how bullish or bearish investors are about the market, hence it provides insight into the potential direction of an individual stock. Simply put, investor sentiment is represented by a large increase or decrease in a stock’s short interest position. For instance, if the short interest of a company increases from 10% to 20%, it may be a warning sign that investor sentiment is growing bearish and negative on a company.

Stocks that have high short interest readings are more prone to short squeezes. Investopedia defines a short squeeze as an upward price move caused by investor buying coupled with short sellers being forced to buy to cover their positions, so they don’t take too large of a loss. Therefore, identifying stocks with a significantly high short interest position may allow you to identify the next new target for meme stocks traders. Meme stock traders have bet that the hedge funds and other financial institutions heavily shorting these meme stocks are overleveraged. Hence, meme stock traders behave on the premise that the power of a retail-led push would force them to ultimately drive the price even higher when having to close out their short position. Consequently, allowing meme stock traders to capitalize from an early upswing in their stock price.

Consequences of Meme Stocks

Retail investors can move markets significantly.
The meme stock craze has forced hedge funds and money managers to start paying much more attention to what small retail traders are doing.
Equity markets are changing rapidly, and perhaps the shift will be permanent.
Long gone are the days where retail investors will readily accept big profitable moves by financial institutions and hedge funds at the expense of retail investors.

The Bottom Line

Trading or investing in the meme stock craze is a risky and highly speculative play. The key to trading meme stocks is having an understanding of taking advantage of the system. Occasionally, the conditions are so ripe for a stock to rocket higher that it can surge far past anyone’s imagination. However, it is critical for traders to have a fundamental understanding of performing technical analysis to determine entry and exit points at the very least.

Often, we are only exposed to the success stories of traders making heaps of money in the early days of the meme stock trading frenzy. However, there has been a fair share of investors who have expressed deep regret in looking to chase easy gains.

As with any investment opportunity, thread carefully and intelligently!

Deepak Singh is an Authorised Representative of Global Financial Consultants Pte Ltd – No: 200305462G | MAS License No: FA100035-3

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General Information Only: The information on this site is of a general nature only. It does not take into account your individual financial situation, objectives, or needs. You should consider your own financial position and requirements before making a decision.

*Please note that Deepak Singh is not a tax agent or accountant and none of the content outlined here should be taken as personal advice. You should consult your tax agent and financial adviser to review your current personal finances and financial goals to consider whether this strategy is appropriate for you.