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An Ultimate Guide of Meme Stocks

Published by MEXEM EUROPE

June 6, 2024 12:32 PM
(GMT+2)

In an evolving world of finance, meme stocks have become a notable trend, captivating investors and analysts with their rapid ascents in the market. These stocks, typically shares of companies that leap in price due to intense online attention, gain momentum from viral social media posts and dedicated discussions on community forums such as Reddit.

Imagine the thrill of seeing a stock's value skyrocket in hours, driven by a large online community. However, the promise of quick profits comes with high volatility and risk. Understanding the unique dynamics of meme stocks is crucial for those intrigued by this volatile yet exciting market segment. 

Key Concepts of Meme Stocks:

Viral Popularity:
Meme stocks gain attention through social media, where online communities such as the Reddit forum WallStreetBets which discuss, analyze, and promote specific stocks. This reliance on social media buzz can result in significant price volatility.

Community-Driven:
These stocks often see heavy discourse on forums like Reddit’s / Wallstreetbets, where users collectively decide on target stocks and promote them.

Short Squeezes:
Meme stocks can trigger short squeezes, where heavily shorted stocks see rapid price increases as short sellers are forced to cover their positions, buying back the shares at higher prices.

High Volatility:
Meme stocks are characterized by significant volatility, driven by viral posts and coordinated buying, often leading to overvaluation compared to traditional technical analysis.

Recognizable Brands:
Meme stocks often come from companies with well-known brands that have seen better days. These stocks resonate more with individual investors compared to less recognizable ones.

Potential for Trend Trading:
Owning stocks with these characteristics doesn't guarantee they will become meme stocks, but they might be subject to similar trading patterns, leading to irregular trading activity.

Short Squeeze in Meme Stocks

A short squeeze is a phenomenon often associated with meme stocks, where heavily shorted stocks experience a rapid increase in price, forcing short sellers to buy back shares at a loss to cover their positions.

Short Selling Explained:

Short selling is a trading strategy where an investor borrows shares of a stock they do not own, sells them at the current market price, and hopes to return them later at a lower price to return to the lender. This strategy bets on the decline of the stock's price. Key points include:

  • Borrowing Shares: The short seller borrows shares from someone who owns them.
  • Selling High: The short seller sells the borrowed shares at the current market price.
  • Buying Low: The goal is to repurchase the shares at a lower price, return them to the lender, and pocket the difference.

However, if the stock price rises instead of falling, the short seller faces potential losses because they must buy back the shares at a higher price.

Meme Stocks and High Short Interest

Meme stocks, such as GameStop {{ m-tag option="price" ticker="GME" currency="USD" }}, are often characterized by high levels of short interest, meaning a significant portion of the company's shares are sold short. Retail investors on platforms like Reddit's WallStreetBets noticed this high short interest and saw an opportunity.

The Role of Hedge Funds and Short Selling
  • Hedge Funds are investment funds that pool capital from wealthy investors. They often engage in sophisticated trading strategies, including short selling.
  • Short Selling: This involves borrowing shares of a stock and selling them immediately with the expectation that the stock price will decline. If the price drops, the short seller can buy back the shares at a lower price, return them to the lender, and pocket the difference.

For Example:

  • If a short seller borrows shares and sells them at $10, hoping the price will fall but rises to $50, the short seller owes $40 per share.
  • If the stock price soars to $500, the short seller's losses become even more substantial.

GameStop Phenomenon

The meme stock phenomenon, particularly involving GameStop, began in late 2020. Several factors contributed to its rise:

  • Online Forums: Retail investors on Reddit, particularly the WallStreetBets forum, rallied around GameStop.
  • Lockdown Conditions: COVID-19 lockdowns kept many potential investors at home.
  • Trading Apps: The rise of commission-free trading apps made trading more accessible.
  • Stimulus Checks: US government stimulus checks provided additional funds for many individuals.

Renewed Interest in 2024
In May 2024, interest in GameStop was reignited:

  • Roaring Kitty's Return: Keith Gill, known as Roaring Kitty, posted on social media for the first time in three years. Although he didn't mention GameStop, his return sparked fresh investment.
  • Stock Surge: GameStop's price increased by over 74% in a single day, reaching $64 on May 14 before dropping below $40 a few days later.

Analysis and Sustainability
Differences between the 2021 and 2024 events:

  • Short Positions: In 2021, many positions were short, driven by lockdowns and reduced spending in physical stores. In 2024, the percentage of shorts was much lower, reducing the potential for a similar frenzy.
  • Market Fragility: the sustainability of the May 2024 rally is fragile, and momentum can quickly shift.

Conclusion:

Meme stocks have become a significant financial market trend driven by social media and online communities. Often discussed on platforms like Reddit, these stocks gain popularity and see rapid price increases due to coordinated buying efforts. However, they are characterized by high volatility and risk, as seen in the GameStop phenomenon. Retail investors' collective actions led to massive price surges, impacting institutional short sellers. Lockdowns and stimulus checks fueled the 2021 surge, while renewed interest in 2024 was sparked by social media activity. Understanding the dynamics of meme stocks is crucial for investors navigating this unpredictable market.

The information on mexem.com is for general informational purposes only. It should not be regarded as investment advice. Investing in stocks involves risk. A stock's past performance is not a reliable indicator of its future performance. Always consult a financial advisor or trusted sources before making any investment decisions.

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