Meme Stocks Explained: What Are They and Why Do They Matter?

Social media has introduced a new type of stock phenomenon — meme stocks. These stocks can experience extreme price swings based more on online popularity than financial fundamentals, making them volatile and often risky investments. This article explains what meme stocks are, their history, and how they may affect the market.

What is a meme stock

A meme stock is a stock that gains popularity and experiences significant price changes due to social media activity, rather than the company’s actual financial performance or business fundamentals. Platforms like Reddit, Twitter, and YouTube contribute to the hype surrounding these stocks, with retail investors amplifying price changes through collective action. Meme stocks are often highly volatile, experiencing dramatic surges and drops, sometimes without clear financial reasoning.

How does a meme stock work

Meme stocks primarily work through collective social media hype, which drives some retail investors to purchase shares en masse. In certain cases, this can lead to what’s known as a “short squeeze,” where investors who took a short position in the stock by short selling are forced to buy shares to cover their positions as prices rise, creating even more buying pressure. However, this hype-based rally is often disconnected from a company’s financial outlook, making meme stocks risky, especially for those who may not have experience navigating volatile investments.

Examples of meme stocks

Several stocks have gained "meme status" with some online news sources, often due to intense online interest and high short interest. Examples include:

• GameStop (GME): A video game retailer whose stock price surged in 2021, primarily driven by Reddit's WallStreetBets.

• AMC Entertainment (AMC): A theater chain that attracted meme stock attention during the pandemic.

• Bed Bath & Beyond (BBBY): Experienced price surges due to retail investors rallying online.

These stocks became popular as online communities coordinated to buy shares, highlighting how meme stocks can quickly gain traction, but also illustrating the risks involved as prices often plummeted after the initial hype faded.

History of meme stocks: Why do they matter

Meme stocks rose to prominence in early 2021 when online communities of retail investors, especially on platforms like Reddit, drove up the prices of heavily shorted stocks like GameStop and AMC. Meme stocks gained attention as a symbol of retail investors’ collective power, leading to discussions about market dynamics, transparency, and the ethical implications of social media’s influence on stock prices.

The trend underscored how rapidly coordinated buying and selling could lead to extreme price volatility, drawing the attention of regulators and the broader financial industry.

Short selling and meme stocks

Short selling is the process of selling borrowed stock at the current price, then closing the trade by purchasing the stock at a future time. What this means is that, if the price drops between the time you enter the trade and when you deliver the stock, you can turn a profit minus any fees or expenses.

The connection between short selling and meme stocks is worthwhile understanding. In many cases, meme stocks are targets for “short squeezes” because they have high short interest (where many investors are taking positions against them). When the price rises suddenly, many short sellers must buy back shares to avoid further losses, adding more upward pressure. However, this process can also lead to equally dramatic losses for retail investors if prices drop just as quickly. For retail investors trading on margin, this volatility can trigger margin calls — a demand from their broker to deposit additional funds to maintain their position. If investors are unable to meet the margin call, their broker may liquidate assets to cover the shortfall, potentially locking in significant losses. This adds another layer of risk, as dramatic price volatility can leave investors on both sides exposed to financial losses and forced liquidations.

Terms related to meme stocks

Meme stock communities use specific terms to describe their trading activities and sentiments. These terms reflect the speculative and often high-stakes nature of meme stock trading:

• YOLO (You Only Live Once): High-risk, high-reward trading decisions.

• FOMO (Fear of Missing Out): Impulsive buying driven by the fear of missing potential gains.

• Diamond Hands: Holding stocks despite volatility, signifying strong conviction.

• Paper Hands: Selling stocks quickly due to volatility.

• Short Squeeze: Rapid buying pressure forcing short-sellers to cover positions.

• HODL (Hold On for Dear Life): Holding stocks despite market fluctuations.

• FUD (Fear, Uncertainty, Doubt): Negative information spread to influence stock prices.

Potential benefits and risks of meme stock investing

Investing in meme stocks may provide short-term gains due to sudden price increases spurred by social media. Some investors appreciate that meme stocks give retail investors a chance to influence markets. However, meme stocks are generally unpredictable, are not appropriate for many investors, and their price movements are often disconnected from the company’s financial health. Investors may face steep losses when momentum fades or short squeezes unwind.

FAQs about meme stock trading

Why is it called a meme stock?

Meme stocks get their name from internet memes, as their popularity and price swings are influenced more by social media trends than by financial fundamentals. The term reflects their viral nature on platforms like Reddit.

Are meme stocks considered a good investment?

Due to their volatility and reliance on social media hype, meme stocks are often risky and speculative. While they can lead to quick gains, their prices can also crash just as quickly, making them unsuitable for most long-term investors.

What are some of the most known "meme stocks"?

Historically popular meme stocks include GameStop (GME), AMC Entertainment (AMC), Bed Bath & Beyond (BBBY), BlackBerry (BB), and Nokia (NOK), all of which have experienced significant social media-driven price movements.

How do you identify a meme stock?

Meme stocks can often be identified by unusually high social media activity, abnormal trading volumes, sharp price volatility, and heavy interest from retail investors. Monitoring these indicators can help identify meme stocks, though investing in them remains risky.

Why do the share prices of meme stocks sometimes experience a sudden rise?

Price surges in meme stocks are often driven by a combination of social media buzz, collective retail investor action, short squeezes, and media coverage. These factors can lead to rapid price spikes, but they often lack the underlying stability of traditional stocks.

A short squeeze occurs when a stock heavily shorted by investors suddenly rises in price, forcing short sellers to buy shares to cover their positions. This buying activity creates further upward pressure on the stock price, leading to an explosive rally. Meme stocks, which often attract significant short interest due to perceived overvaluation, can become prime candidates for short squeezes.

For example, when retail investors on platforms like Reddit identify heavily shorted stocks, they may coordinate buying efforts to drive the price up, triggering a short squeeze. This cascade effect can propel meme stocks to dramatic highs within a short timeframe, although these gains are often temporary.