Meme stock investing

Even if you don’t care about stocks, you must have heard of the buzzword “meme stocks”. Do you wonder why these stocks have become so popular? How are they different from other stocks?

We will explain in this article how meme stocks operate and how they perform in comparison to FAANG stocks. “FAANG” is the acronym that represents the stocks of the five top U.S. technology companies: Facebook, Amazon, Apple, Netflix, and Google, a subsidiary of Alphabet. These stocks represent 15% of the S&P 500 and their performance has a substantial effect on the overall market. Now, let’s come back and try to understand the mania around meme stocks.

A meme is an image, video, text, typically funny and amusing in nature, that goes viral among internet users, often with slight variations. The term meme was not originated online. It was published in “The Selfish Gene”, a book authored by Richard Dawkins, where he used meme to describe an idea or behavior that spreads across people in a culture.

The virality of meme stocks happens in a similar fashion and hence the name. Meme stocks’ prices increase solely due to social media interest and not based on any fundamental value. Social media platforms like Reddit, Stocktwits, and Twitter, contributed massively to such artificial escalation. This meme stock frenzy is particularly driven by young investors with a high appetite for risk, gaming, and social interactions. The combination of the right psychographics in the right social settings has fueled the unreasonable hike in prices in a short period of time, naturally, followed by an inevitable fall.

One of the most hyped meme stocks was GameStop (GME). For the past few years, GME, a video gaming, and consumer electronics retailer experienced financial hardship and had a rocky time, particularly during the pandemic. Its share price plummeted from $30 in Jul 2016 to $18 in Dec 2020. Suddenly, at the beginning of January 2021, some retail investors on wallstreetbets, a Redditt forum, encouraged each other to buy this stock causing its value to skyrocket. In a matter of days, its share price peaked at $347, 1900% up, on Jan 25, 2021.

When GME’s share price started soaring, the short-sellers began to lose a lot of money, which resulted in a ‘short squeeze’, effectively pushing the price of the stock up even further. On Jan 28, the stock hit an all-time high of $483. Now you must be wondering how short selling and short squeezing impact the meme stocks. Let’s understand it here.

Short selling is a trading strategy, where investors sell stocks they’ve borrowed in hopes of buying them back later for less, as they expect the price of the stock to fall. These short-sellers are usually the hedge funds or other institutional investors, who borrow the shares from their broker. They believe that the stock is overvalued and will eventually plummet. The profit earned by these hedge funds is the difference between the selling and the buying price. However, if contrary to their expectations, the share price starts increasing, then these investors need to act fast to limit their losses since short sales have an expiration date. In an event of a continuous price increase, the short seller position gets squeezed as there are more retail investors buying the stocks and other short-sellers are exiting and closing their bets. To exit their position, these short sellers start buying the stocks, which pushes the price further higher. This unexpected increase in stock price is called a short squeeze that hits the short-sellers particularly hard, as they might end up spending more money to rebuy and return the borrowed stock.