Meme stocks are a relatively new concept that can be traced in 2020 during the coronavirus pandemic when the Federal Reserve lowered interest rates and launched its biggest quantitative easing program in the world.
The first meme stock was Hertz, a company whose shares soared after it filed for bankruptcy. In this article, we will look at what meme stocks are, some examples, and some strategies to trade them.
What are meme stocks?
These stocks are companies whose share prices are mostly influenced by activities in social media platforms like Reddit and StockTwits. They are characterized by a sudden parabolic pop and increased messages about it in social media.
In addition to high social media activities, meme stocks have other characteristics.
For example, most of them are companies whose businesses are struggling. Just think about this, Hertz became a meme stock when it was struggling while GameStop business model was being challenged as more users started to download games and buy consoles online. Similarly, AMC Entertainment has entered this type of stock at a time when the theatre business was in turmoil following the Covid lockdowns.
Meme stocks also seem to be companies with a high short interest. For starters, short interest refers to a situation where a substantial number of shares of a public company are held by short-sellers, who are investors who benefit when the stock declines. They achieve this by borrowing shares, converting them into cash, and then buying them back when they drop.
Some Current Examples
The number of meme stocks is constantly growing. As of June 2021, some of the most popular meme stocks are companies like:
- GameStop - It is an old-fashioned console and video game seller that is facing strong competition from online platforms. Its stock jumped from less than $20 to almost $500 within a few days (thanks to a Sub-Reddit).
- AMC Entertainment - It is the largest movie theatre chain in the world. Its short interest grew as governments and states announced lockdowns to curb the coronavirus.
- Clover Health - It is a company that went public in 2021 and attracted a deep short-seller report that pushed its share price lower and short interest higher.
- Workhorse Group - It is an electric car manufacturer that short-sellers believe will go out of business because of its high cost of doing business.
- Lordstown Motors - It is another EV maker that highlighted going concern issues in June 2021.
- ContextLogic - It is the parent company of Wish.com, a popular mobile e-commerce platform known for selling cheap products.
How meme stocks work
The concept of meme stocks has been around for years. It is a concept that was commonly known as pump and dump scheme. This is a process where an individual or group of investors target a company and decide to push it to public investors.
In the past, they did this by delivering reports and making a media blitz about their holdings. All this usually push stock prices higher. As this happens, they then start selling, leaving vulnerable traders holding the bag.
Meme stocks work in the same way with the only difference being that the participants are now using social media platforms. The process starts when traders identify a company with a big short interest. They then start promoting it in social media platforms. This tends to attract the attention of other retail traders who rush to buy the stock. Ultimately, the stock shares climb and then decline sharply.
There are several factors that made the meme stocks “industry” boom in 2021. First, interest rates were incredibly low during the coronavirus pandemic (check here to understand how to interpret these data). That pushed more people to try trading to avoid missing out.
Second, there is the fact that all retail-facing brokers are offering free services in that they are not taking a commission. That has incentivized more people to trade.
Third, there is the fact that many Americans accumulated a lot of savings during the pandemic. This happened since most of them were staying at home and not taking costly foreign vacations. Most importantly, the government provided them with free money in form of stimulus. Some of these funds were deployed to retail trading.
Finally, there was the fear of missing out. As the meme stock craze continued, people were influenced to trade by their friends and colleagues who were making a fortune in the stock market. This pushed them to trade as well.
How to trade meme stocks
We have already looked at this in recent articles on parabolic moves and in our Wall Street Bets article. Ideally, we recommend that you create a watchlist of these companies. TradingView offers an easy way to create a watchlist. As you do this, ensure that you set the watchlist to show activities in extended hours. Another very important source that we suggest you check out is TraderTv's watchlist.
You should start your trading day by looking at the top performers during the extended hours period. These are some of the companies that you should pay a close attention to. After identifying the top movers, the best way is to use pending orders and stop losses.
For example, if a stock is up by 10% in premarket and is trading at $12, you could set a buy-stop at $14 and a stop loss at $16. You should also set a buy-stop at $17 and a take-profit at $19, and so on. By so doing, you will be able to follow the trend (a good strategy, as we explained before) while taking minimal risks.
Please note that meme stocks are ideal for day traders and not swing or position traders. As such, you should ensure that you close your trades before the end of the day.
Meme stocks have made a lot of headlines recently. Today, they are some of the most actively traded stocks in Wall Street. In this article, we have looked at how they happen and some of the simple strategies to trade them.
We know the topic is sensitive and not everyone is in favor of this type of stock. What is your opinion on this?
External Useful Resources
- A Meme Stock Is Born: How to Spot the Next Reddit Favorite - Bloomberg