The COVID-19 lockdowns were a game changer for society in critical lifestyle areas like the workplace, the economy, technology and travel.
Make no mistake, Wall Street trading wasn't immune to the ravages of the pandemic.
With more people at home starting in 2020, social media became a major hangout for marginalized stock market investors. Out of widely bookmarked platforms like Reddit, YouTube, TikTok and Twitter (among others), a new trading strategy emerged from lockdown-market luminaires: the "meme stock."
A meme stock is a company that generates a buzz on social media that shines a Hollywood-sized Klieg light on an investment that's otherwise widely ignored.
"A meme stock is a stock that has become popular and traded heavily (because of) social media, often due to a viral meme or online community," says Seth Diener, private wealth manager at the financial advisory firm Diener Money Management. "These stocks are often volatile and can experience sharp price swings, making them a risky investment for novice investors."
As the buzz intensifies, meme stock hype can go into overdrive and pump up the shares of often underwhelming, thinly traded stocks. Flagship meme stock GameStop Corp. (GME) and AMC Entertainment Holdings Inc. (AMC) are prime examples. And often, there's no benefit for bandwagon investors: Long-running meme stock Bed Bath & Beyond ultimately filed for bankruptcy in April.
In 2021, a GameStop buying frenzy driven by Reddit investors sent shares skyward in a history-making rally that squeezed out hedge fund short sellers. Market watchers have speculated about what would happen if meme-stock buying kept happening at that same manic level.
As for GameStop, its shares came back down to earth, and its turnaround quest hit another roadblock Thursday, as it reported first-quarter results that fell short of analysts' expectations. It also announced the firing of CEO Matthew Furlong and the appointment of Ryan Cohen as executive chairman. Shares had fallen about 17% as of midday.
Here's what you need to know about meme stocks, with a word to the wise about how they should be treated in an investment portfolio:
- The normalization of meme stocks.
- Underperformance as a theme of meme stocks.
- Regulation of meme stocks, or lack thereof.
- If you still want to buy meme stocks.
The Normalization of Meme Stocks
"Since the GameStop and AMC meme stock explosion in 2021, meme stocks have become more volatile and less predictable," Diener says.
Slapping a normalized label on meme stocks hasn't helped matters. "Unfortunately, meme stock 'investing' has been normalized because much of the media incorrectly refers to the practice as investing instead of speculating," says Robert Johnson, a professor at the Heider College of Business at Creighton University.
The reality is that there are only a few upsides and multiple downsides to meme stocks.
"There's the potential to get in on a stock early and to make high returns," says Sam Boughedda, equities trader at AskTraders.com. "However, both of those require a lot of luck."
On the other hand, risks abound with meme stocks that novice investors aren't likely to consider before pressing the "buy now" tab with their broker.
"Extreme volatility is a big issue," Boughedda notes. "Due to the nature of meme stocks, investors usually don't take into account the company's current fundamentals, and they're also at the mercy of online-driven pump-and-dump schemes."
Underperformance as a Theme of Meme Stocks
Once a spotlight shines on meme stocks from a performance point of view, the meme dream begins to wither.
A case in point is a recent study from Bloomberg Intelligence that compares three different stock market performance metrics over the period of 2010 to 2022: a "low meme stock" basket of stocks, a "high meme stock" basket of stocks and the U.S. stock market as measured by the Russell 3000 Index.
The study defined meme-stock trading characteristics by combining near-term trading volume, measured by 20-day volume; and short interest, or the percentage of traded shares that were sold short. Here's the performance for each category:
| BASKET OF STOCKS | TOTAL RETURN, 2010-2022 |
| Low-meme-stock characteristics | 355% |
| High-meme-stock characteristics | 11% |
| Russell 3000 Index | 275% |
The results point to two common problems with meme stocks: high volatility and the equally high potential for market manipulation.
"Meme stocks often don't have a solid foundation and can swing in price, lacking long-term stability," says Jonathan Merry, CEO of Moneyzine.com, a digital finance and investment platform.
Meme stocks are susceptible to market manipulation due to their popularity among online communities. "Coordinated efforts to inflate or deflate prices can lead to artificial distortions in the market," Merry says.
The last point represents perhaps the biggest risk to novice investors: Meme stocks aren't really driven by solid investment fundamentals like quarterly earnings, liquidity or leadership stability.
"Novice investors should be careful if they choose to invest in meme stocks," says Frank Corva, senior analyst for digital assets at financial information resource Finder in New York City. "Usually, by the time a novice investor has heard about a meme stock, that stock has already (jumped) in price quite a bit."
This often results in beginner investors becoming what more seasoned investors call "exit liquidity."
"If you're the exit liquidity, you're one of the lesser-knowing people in the trade who's buying in when the more experienced or well-connected investors are selling," Corva says.
Corva points to the cryptocurrency markets as an example.
According to Finder's Consumer Confidence Index, Dogecoin (DOGE), a crypto meme coin, was the first coin bought by 12% of polled crypto investors.
"Chances are they didn't buy DOGE at the lows," says Corva. "They probably bought in while it was pumping and got left holding the asset as it decreased in value."
Regulation of Meme Stocks, or Lack Thereof
There aren't any special rules around meme stocks or meme coins, although the U.S. Securities and Exchange Commission did institute a rule change to reduce the standard settlement cycle for the majority of broker-dealer transactions in securities, from two business days after the trade date to one day.
"That rule is designed to reduce the credit, market and liquidity risks associated with meme stocks," Boughedda says. "However, there could be more to come, with SEC Chair Gary Gensler stating the settlement shift addresses only one of four areas recommended by staff for the SEC to address in response to the meme stock craze."
If it sounds like federal regulators are leaving much of the meme-stock market to regulate itself (the low-performance numbers linked to memes certainly help on that front), that's not by accident.
"There really are no rules when it comes to meme stocks," Johnson says. And that indirect neglect leaves the field open for more meme grifts.
"The concept of meme stocks hasn't changed much since the GameStop and AMC meme stock explosions," Corva says. "We recently saw the exponential rise (and fall) of the meme coin Pepe (PEPE) in less than a month."
The main difference between the GameStop and AMC meme stock events and what happened with the PEPE coin, however, is that PEPE happened on a much smaller scale.
"Part of the reason for this is that there's far less liquidity being pumped into the market right now," Corva says. "In 2021, the Fed was still pumping money into both the real and financial economy. This is no longer the case, and, hence, meme stock price rallies aren't as prevalent or as notable."
If You Still Want to Buy Meme Stocks
If you're inclined to log on to an online meme stock channel and start placing some bets, do your homework first and know what you're getting into.
"Investors looking to get involved in meme stocks should understand the risks involved," Diener says. He recommends taking these tips into consideration when you want to buy and sell meme stocks:
Do your research. Before you invest in any stock, it is important to do your research and understand the company's fundamentals. "This includes looking at the company's financial statements, reading analyst reports and following news about the company," Diener says.
Only use money you can afford to lose. Meme stocks are a risky endeavor, so it is important to only commit money that is not essential to your financial plan.
Set a stop-loss. A stop-loss is an order that automatically sells your shares if the stock price falls below a certain level. "This can help you limit your losses if the stock price starts to decline," Diener says.
Don't get caught up in the hype. It's easy to get swept up in the excitement of a meme stock, but hold the line when you need to. Remember that these stocks are often volatile.
Takeaway
With knowledge on your side, is it still a good idea to trade meme stocks?
"Either 'just say no,' or have a very small budget and consider your meme stock experience as 'entertainment' and not investing," Johnson says.
