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All you need to know about Meme stocks

Kumar Shankar Roy | Updated on June 29, 2021

Meme stocks, what many believed was a pandemic-induced diversion, seems to be staying on as a trend. Beginning with AMC Entertainment, GameStop and Blackberry, the list of meme stocks keeps on growing. Under attack from the small-guy dominated meme stock army, hedge funds who short-sold these stocks have lost a whopping $12 billion in just six months, forcing some to shut shop.

What is it?

The term ‘meme stocks’ refers to under-the-radar stocks listed in the US market, usually without fundamentals, that suddenly catch the fancy of individual investors or day traders because they’re the subject of social media attention. Meme stocks usually start to rise as retail investors gang up on forums such as Reddit to thwart big guys such as hedge funds with short (sell) positions and buy them just for the fun of it. But such stocks, once they get going, can acquire a momentum of their own that defies all known metrics of valuation.

Such stocks have seen huge gains, sometimes 50-100 per cent in a day, after day traders, inspired by discussions on message boards such as Reddit, started buying them in a coordinated manner. This has caught out short sellers such as large hedge funds such as Melvin Capital and White Square Capital. Short sellers make losses when a stock price rises (they’ve sold the stock without owning it) and have to buy more stock to cover their positions. This propels prices even higher.

Why is it important?

When it started, the meme stocks phenomena was heralded as a fight-back of sorts by small investors against a system which had wronged them for decades. It was like the Occupy Wall Street movement, but with the small guys actually winning the battle. But liquidity sometimes creates its own fundamentals and such concerted stock buying has helped some down-and-out companies raise new capital to try for a turnaround. Cinema theatre chain AMC Entertainment and video game retailer GameStop have raised over $1 billion each after their stock rallies this year. Meme investing has also meant that the risks of short-selling have gone up manifold.

A few hedge funds have first-hand witnessed modestly-sized short positions turn into extinction-level events. So, trading systems are now on a constant lookout for early warning signs of a retail-driven stock surge, co-ordinated buying and chatter etc. Plus, short-sellers are reducing the size of bets.

Why should I care?

Jeremy Grantham, co-founder of GMO and financial historian, recently called meme investing ‘the biggest fantasy trip of all time’ while calling out the ongoing asset bubble in the markets. The trend offers cautionary tales that are universal. Artificial stock price increases, not backed by fundamentals, cannot sustain for long. Meme stocks have not only zoomed, they have also plummeted by hefty percentages on more than a few occasions. With global investing platforms allowing Indians to invest in US stocks, newbie investors ought to watch out against getting misled into mistaking meme stocks for great investments. When early investors start selling, stocks can crater, with people who came in late left holding the bag.

Lastly, the meme stock mania clearly targets short sellers (bears). To enjoy the advantages of a free market, both buyers and sellers, bulls and bears, are required. A market without bears would be incomplete and pose financial stability risk.

The bottom-line

Meme stock investing may be entertaining, but losing real money is not.

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Published on June 28, 2021

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