7 tips for trading meme stocks with success

Published: 29. February 2024

In recent years, the financial markets have witnessed the meteoric rise of a new phenomenon known as “meme stocks.” These are stocks that have gained popularity and seen their prices soar not necessarily because of strong fundamentals or impressive financial performance, but largely due to viral attention from retail investors on social media platforms and internet forums like Reddit. Meme stocks have turned traditional investing on its head, demonstrating the powerful influence of collective retail trading and how it can drastically impact the stock market. This article will dive into the world of meme stocks, exploring their origins, how they’ve changed the landscape of investing, and the opportunities and risks they present to both seasoned investors and newcomers alike.

What is a meme stock?

A meme stock refers to a stock that gains popularity and sees its price increase not primarily due to the company’s financial performance or fundamentals, but rather due to viral attention on social media and online forums. This phenomenon is largely driven by retail investors, particularly those from communities like Reddit’s WallStreetBets, who band together to buy shares and options in companies they believe are undervalued or to trigger short squeezes. The term “meme” comes from the idea that these stocks are popular for reasons similar to internet memes—spreading quickly and widely online, often fueled by humor and a sense of rebellion against traditional financial institutions.

While there’s a perception that meme stock communities organize themselves to manipulate the prices of certain stocks, the reality is that these shareholders are typically a disparate group of individuals, each acting based on their own investment strategies and preferences. Together, however, their separate actions have the power to trigger short squeezes, especially in stocks that are heavily shorted. Consequently, the value of meme stocks can skyrocket, often reaching levels that far exceed what traditional fundamental technical analyses would suggest.

Understanding meme stocks

A meme is an idea or a piece of popular culture that spreads widely and quickly across people’s consciousness. With the growth of the internet and social media, memes have become increasingly prevalent, serving as a means to swiftly share humorous, intriguing, or ironic videos, images, or text with a global audience. The fast-paced and expansive nature of such sharing can propel these posts to viral status.

The digital age also saw the emergence of chat rooms and forums dedicated to investing, contributing to the hype around certain stocks. During the late ’90s and early 2000s, these online platforms played a significant role in hyping up dotcom stocks, leading to a bubble that eventually burst, causing widespread economic fallout.

The concept of meme stocks came into the spotlight in 2020, particularly through the Reddit forum r/wallstreetbets. Distinguished by its unique and often irreverent discourse, WallStreetBets, alongside other similar forums that have since emerged, focuses on identifying and promoting specific stocks, with members actively investing their own funds in these ventures.

Contrary to online pump-and-dump schemes that seek to deceive investors, the movement behind meme stocks is largely driven by a collective strategy of buying and holding these stocks with determination, even after their prices have surged significantly.

GameStop: The first meme stock

GameStop, often called the original meme stock, is a story that captivated the world and highlighted the power of retail investors in the digital age. GameStop, a traditional brick-and-mortar video game retailer, was struggling due to the shift towards digital gaming and the impact of the COVID-19 pandemic on retail. By mid-2020, the company’s future looked bleak, with declining sales and store closures. However, what unfolded in late 2020 and early 2021 was unprecedented and transformed GameStop into a household name beyond the gaming community.

GME surges several hundred percent in January 2021 following online chatter and speculation.

The drama began to unfold on the Reddit forum r/wallstreetbets, a community known for its irreverent tone and risk-tolerant investment discussions. Members of the forum noticed that GameStop was heavily shorted by hedge funds, betting that the company’s stock price would continue to fall. Viewing the company as undervalued and motivated by a mix of profit potential and a desire to challenge institutional Wall Street investors, these retail investors started buying GameStop shares and options en masse.

This collective action led to a short squeeze, where the stock’s price began to rise rapidly, forcing short sellers to buy shares at higher prices to cover their positions, further driving up the stock price. GameStop’s stock, which had been trading around $20 in early January 2021, skyrocketed to an all-time high of nearly $350 by the end of the month. This dramatic price increase resulted in significant losses for hedge funds and showcased the influence and power of coordinated retail investors.

The GameStop saga became a media sensation, sparking debates about market regulation, the role of social media in investing, and the future of retail trading. It also inspired a wave of similar actions targeting other heavily shorted stocks, cementing the term “meme stocks” into the financial lexicon. Beyond its financial implications, the GameStop phenomenon became a cultural moment, symbolizing a populist revolt against the financial establishment and illustrating the shifting dynamics of the stock market in the era of social media and retail investing.

Other meme stocks

Following the unprecedented saga of GameStop, several other stocks have captured the spotlight as “meme stocks,” driven by similar dynamics of social media influence and retail investor coordination. These stocks, often struggling companies or those seen as underdogs by the investing community, have experienced significant price volatility and attention due to their viral status on platforms like Reddit’s r/wallstreetbets.

AMC Entertainment: The movie theater chain became a meme stock favorite in 2021, as retail investors rallied to support the company, which was severely impacted by the COVID-19 pandemic closures. Like GameStop, AMC saw its stock price surge from a few dollars to over $60 at its peak, fueled by a mix of enthusiasm for the brand, speculative trading, and a desire to squeeze short sellers.

BlackBerry: Once a leader in the smartphone market, BlackBerry’s shift towards software and cybersecurity didn’t prevent it from becoming a target for meme stock investors. Driven by nostalgia and speculation on its potential turnaround, BlackBerry’s stock experienced several price spikes, drawing attention from the same cohort that propelled GameStop and AMC.

Nokia: The Finnish telecommunications company, known for its mobile phones in the early 2000s, became another meme stock when traders on social media platforms began promoting it. Despite its efforts to reinvent itself in the telecom equipment industry, Nokia’s stock became subject to wild price swings as part of the meme stock phenomenon.

Bed Bath & Beyond: This home goods retailer experienced fluctuations in its stock price due to attention from meme stock traders. Facing challenges from e-commerce competition and changing consumer habits, Bed Bath & Beyond became a target for retail investors looking to support struggling companies and potentially profit from short squeezes.

These examples illustrate the broader trend of meme stocks, where social media and retail investor activism can lead to rapid and sometimes unsustainable changes in stock prices. While these movements have offered opportunities for significant gains, they also come with substantial risks, as the volatile nature of meme stocks can lead to equally rapid losses. The phenomenon has sparked discussions about market dynamics, investor behavior, and the need for regulatory scrutiny in the era of social media-driven investing.

Are meme stocks worth trading?

The allure of trading meme stocks lies in their potential for rapid and significant returns, as seen in the meteoric rises of companies like GameStop and AMC. However, this potential comes with high volatility and substantial risk. Meme stocks are driven more by social media hype and retail investor sentiment than by traditional financial metrics and company fundamentals, making their movements unpredictable and susceptible to sudden reversals. For traders with a high risk tolerance, an appetite for quick decision-making, and a keen sense of market sentiment, meme stocks can offer exciting opportunities. Yet, for those seeking more stable investments or who are risk-averse, the erratic nature of meme stocks might not align with their investment strategy. Ultimately, whether meme stocks are worth trading depends on an individual’s financial goals, risk tolerance, and ability to navigate the frenzied market dynamics that define these unique assets.

7 tips for trading meme stocks

  1. Choice of Broker: Most meme stocks are established companies listed on major stock exchanges like NASDAQ and NYSE. You should find a broker with access to these major exchanges.
  2. Do Your Homework: Beyond the memes and social media buzz, a solid understanding of the company’s fundamentals is crucial. Investigate its revenue streams, debt levels, and competitive positioning. Even if trading decisions are based on market sentiment, knowing the basics can help you assess the potential floor or ceiling for a stock’s price.
  3. Set Clear Entry and Exit Points: Establishing predetermined prices at which you’ll buy and sell can prevent emotional decision-making in the heat of the moment. Decide on these thresholds by considering historical data, recent price action, and your personal risk tolerance. This approach can help lock in profits and limit losses.
  4. Use Stop-Loss Orders: Given the unpredictable swings in meme stock prices, stop-loss orders are a critical tool. They automatically execute a sell order if the stock falls to a certain price, helping protect against deeper losses. Adjust these levels as the stock moves to safeguard gains or prevent further downside.
  5. Stay Informed: The momentum of meme stocks is often influenced by news, rumors, and sentiment shared on platforms like Reddit and Twitter. Regularly monitoring these sources can offer early signals of shifting trends or sentiment, giving you a chance to adjust your positions accordingly.
  6. Be Prepared for Volatility: The rapid price fluctuations of meme stocks are not for the faint-hearted. Mental preparation and a clear strategy can help you stay calm and collected. Recognize that significant intraday swings are common, and don’t let fear or greed dictate your trading decisions.
  7. Diversify Your Portfolio: While the allure of quick gains from meme stocks is tempting, they should only represent a small portion of your investment portfolio. Diversification across different asset classes and sectors reduces risk and provides a buffer against the volatility of meme stocks. This balanced approach helps ensure that a single bad trade won’t significantly impact your overall financial health.

By adhering to these strategies, traders can better navigate the high-risk, high-reward world of meme stocks with a balanced approach that respects both the opportunities and the dangers inherent in this unique segment of the market. And as always, remember to never invest more than you can afford to lose.

Conclusion

The bottom line in navigating the whirlwind world of meme stocks lies in striking a careful balance between seizing potential opportunities and managing the inherent risks. While the allure of quick profits can be enticing, the volatile nature of meme stocks demands a disciplined approach, grounded in research, strategic planning, and an unwavering commitment to risk management. By doing your homework, setting clear trading parameters, employing protective measures like stop-loss orders, and only investing funds you can afford to lose, you can engage with meme stocks in a way that aligns with your overall investment strategy and risk tolerance.

Staying informed and prepared for the rollercoaster of price swings, while ensuring your portfolio is diversified, can further safeguard your financial well-being. Remember, the speculative frenzy around meme stocks makes them unpredictable, and while they offer a unique avenue for retail investors to impact the market, they should be approached with caution and a healthy dose of skepticism.

In essence, trading meme stocks is not for everyone, but for those who choose to dive into these turbulent waters, going in with eyes wide open, armed with knowledge and a solid strategy, is imperative. Whether you’re drawn to the camaraderie and anti-establishment ethos of meme stock communities or simply looking for short-term gains, the key to success lies in understanding the game, playing by your rules, and knowing when to walk away.