Wednesday, September 22, 2021
stock exchange

Should you buy a meme stock?

For many Nigerian millennials who are familiar with happenings on Wall Street, or are invested in the US Stock markets, ‘Meme Stocks’ and their occasional rapid price movements don’t come as a surprise. However, even people familiar with these stocks may have a hard time understanding why their prices fly to the moon often or what makes a stock “meme.”

MEME, pronounced “MEEM,” is hard to define; birthed in 2020, these stocks experience sharp price movements as a result of collective and consistent social media chatter, primarily from the Wall Street Bet community on Reddit and other social media apps like Twitter and TikTok, where these stocks are discussed for a period of time with a view to pumping the price to obscene levels.

A few weeks ago, AMC Entertainment (AMC) rose from $15 to more than $70 within a few days as young investors went crazy over this stock with some investors becoming millionaires, while others bought at a price that couldn’t rise again after the euphoria was over.

A Reddit user once described the initiative as a “war of the little guy vs. the big guy in multiple battlefronts.” The shared goal of the Wall Street Bet community on Reddit is to create a short squeeze (I’ll come to this shortly) and spur big losses among the traditional hedge funds that bet against struggling companies in a bid to make their share prices go lower.
There are usually 2 underlying financial dynamics at play that drive these prices to the moon:

A short squeeze
A gamma squeeze
I’ll attempt to briefly explain the concept of the short squeeze and its implication on these stocks.

A brief intro to a short squeeze
The process of short selling has been covered in other articles on this website so I won’t go too deep into explaining it.

In a short squeeze, the ‘short’ refers to the concept of short selling, i.e. betting against a stock that its price will decline, while the short interest is a measure of how heavily an asset is shorted by the market. It is the total number of shares that have been sold short (borrowed and sold) but have not yet been covered (bought and returned). It is usually measured as a % of the number of shares outstanding.
Therefore, a short squeeze occurs when a heavily shorted asset experiences a rapid upward price movement. When this happens, short-sellers may be forced to close their short positions (buy back the stock and return it to the broker) further accelerating the upward price movement.

The most prominent example of a meme stock short squeeze occurred with the struggling video game retailer, Gamestop (GME). GME traded at around $19 per share at the beginning of the year, but by January 28, it got to an all-time high of $483 per share.
Should you buy a meme stock now?
FOMO is one of the main drivers of investor buying. FOMO is an acronym for ‘fear of missing out’ which was originally coined by Patrick J. McGinnis in 2004. This fear is spurred on by the fact that the Gen Z and Y generation, the ones who buy these stocks, are usually on their phones and inundated with updates about activities going on in their social circles.

For example, if a stock moves up +100% in a day and you have people on your Reddit and Twitter feed talking about these stocks in excitement, this creates a psychological pressure and a need for you to also make money and not be left in the trenches when others are moving ahead.

It is generally not advisable to buy meme stocks, especially if your reason is to target a short squeeze. The reason is that these stocks cannot be classified as investments but short term momentum trades. The rise in prices of these stocks are usually short-lived (runs for a number of days) before they run out of steam.

To make money from meme stocks, you need to be the first to start selling after a rise in price, which is impossible to forecast because the rise usually creates a greed-induced euphoria that makes investors believe the run will continue forever.

In summary, meme stocks have some of the following features:

Large volume
Higher short interest than normal
Stock pop
Struggling companies with poor fundamentals
Consistent social media mentions (especially on Reddit)
Some popular meme stocks are Gamestop, AMC entertainment, Blackberry, Nokia, Lemonade, and Beyond Meat, amongst others.

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