Meme stocks: What are they and should you trade them?

It’s fair to say that the big global stock indices have been relatively boring of late. Even though the month of June saw fresh record highs for the S&P 500, NASDAQ 100, and German DAX, with a brief pull- back after a more hawkish-than-expected Federal Reserve meeting, it hasn’t felt as if equity markets have done anything interesting. Instead, we’ve had long periods of minimal intra-day price movements, with an overall glacial grind higher.

These aren’t traders’ markets. Volatility, as measured by the VIX, has fallen back to pre-pandemic levels around the 20 mark. This is still double what it was when compared to a few years ago, but 75% down from the high hit at the end of March last year. This suggests that there’s an air of complacency in the major US and European stock indices. It also means that we’re not seeing the rallies and pull-backs that traders need to encourage them to trade. A look at any stock index chart shows that the most profitable trading tactic since the nadir of the pandemic sell-off in March 2020 has been to ‘buy-and-hold’, and that’s an investing strategy, not a trading one.

However, the fact that the major markets look relatively serene is disguising the turmoil that’s going on elsewhere. Meme stocks are going bonkers, and if you’re after a wild ride, this is where you’ll find volatility.

What is a meme stock?

A stock becomes a meme stock when it suddenly gets lots of mentions on social media. Typically these are US companies with a small-to-medium-sized market capitalisation. It also helps if there’s a large outstanding short position on the stock, as a concentrated buy programme often means the shorts are forced to cover, helping to drive up the stock price.

The meme stock poster child must be GameStop, a tired old bricks-and-mortar games outlet. Earlier this year the stock price soared from just under $20 to over $480 in a fortnight and has remained volatile ever since. The catalyst came as retail traders banded together via the WallStreetBets thread on Reddit and took on the hedge funds shorting the stock.

It didn’t take long for the retail crowd to identify and create other meme stocks including AMC Entertainment, Blackberry, and Bed Bath & Beyond. More recent additions include Clean Energy Fuels Corp., Clover Health Investments, and Workhorse Group. While the trade in meme stocks was driven by a flood of gung-ho retail traders, Wall Street was also quick to get involved. It always is when it sees a money-making opportunity, particularly when it knows it has an edge. Originally, some were caught on the wrong side of the trade. But hedge funds adapt rapidly, and many have set up desks to concentrate on punting meme stocks.

Why do people trade meme stocks?

This kind of stock market fad isn’t a new phenomenon. In fact, we’ve seen many similar examples over the years. There was the telecoms, media, and technology (TMT) boom of the 1990s, followed by the ‘Dot-Com’ mania in the early 2000s. Then we’ve had FANG, FAANG and all the rest. But the current popularity of meme stocks is more akin to the trade in gaming stocks just ahead of the Great Financial Crisis of 2008/9.

In both cases the manic trading is carried out by a relatively small crowd of risk-tolerant traders convinced that they’re able to ride the wild price swings and get out before the bubble bursts. In all trading fads the motivations are the same, only these days we have a couple of acronyms to help us understand them: FOMO (fear of missing out) and YOLO (you only live once). These neatly sum up the spirited attitude prevalent amongst this group of traders.

Of course, we wouldn’t have meme stocks without social media, and in this case it’s the Reddit platform that must take the credit. The WallStreetBets thread is light-hearted, irreverent and profane, where traders boast about their losses and the mickey-taking is merciless. For all these reasons it isn’t the best place to go for trading tips, but it can help you find out which stocks are being talked about.

Are meme stocks for me?

Ultimately, trading is about developing a system that works for you. You need to establish the time you have available to study the markets and apply technical and fundamental analysis. You also need to work out your attitude to risk and how often you’re prepared to trade. This involves creating your own systematic trading plan.

The idea is to make more money than you lose. In contrast, the appeal of meme stocks is that, with a little bit of luck and no effort, you can make ten times your investment in a day or two. But with meme stocks it’s not just deciding when to buy, it’s also working out when to sell. This is notoriously difficult to do if you’re riding on a rollercoaster. If prices appear to be moving irrationally, then it’s very difficult to time your trades, whether opening or closing. It’s sheer gambling.

Now there’s nothing wrong with that if that’s what you want to do, but you should appreciate the volatility and potential irrationality of each trade before you go into it, especially if you’re employing leverage. Make sure you stick to your trading strategy and engage in strict risk and money management. Don’t loosen things up because you’re dealing with a high volatility instrument. And if the trade doesn’t fit into your trading plan, then don’t do it. Stick to what you’re comfortable with. Remember even stodgy old stock indices can move violently, so eventually you’ll find the opportunity to make big profits or losses. It’s true that YOLO, but that’s no reason for FOMO.