What Is a Meme Stock?

Meme Stocks Explained

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A meme stock is a stock that has gone viral online, drawing the attention of retail investors. Meme stocks have greatly risen in popularity as of late. The term made media headlines in early 2021 when the popular meme stock GameStop (GME) skyrocketed in price in a David vs. Goliath–like tale. And while these meme stocks might make for a thrilling news story, they tend to have far-reaching meaning for the average investor. 

Definition and Examples of a Meme Stock

A meme stock is a stock that has seen an increase in volume not because of how well the company performs, but rather because of hype on social media and online forums like Reddit. For this reason, these stocks often become overvalued, seeing drastic price increases in just a short amount of time.

“Meme stocks are not a class of investments that’s covered in a textbook. They can be value or growth companies,” said Misty Lynch, financial advisor and certified financial planner with Beck Bode, in an email to The Balance. “It is really a category for stock that has seen rapid growth and attention on social media channels like Reddit and Twitter. The valuation may not line up with the price changes, or the hype.”

In addition to GameStop, examples of meme stocks include AMC, and BlackBerry. While the companies themselves have not performed well in recent years, all three stocks went viral on a popular Reddit forum, and saw massive price hikes in early 2021, specifically on January 27. BlackBerry’s stock more than tripled, while AMC increased by nearly tenfold. But neither saw the same viral growth of GameStop, whose share price increased by hundreds of dollars in a matter of days.

Meme stocks have become more relevant in recent years thanks to the rise in retail investing. It’s now easier than ever to trade single stocks, meaning more people can take part in these meme stock surges.

How Does a Meme Stock Work?

Meme stocks rise in popularity because of conversations held online. Word travels fast on the internet, and when a stock goes viral by word of mouth, it tends to see rapid price spikes. Because the price increase that follows is artificial and not the result of the company’s actual performance, these spikes are most often followed by an inevitable crash.

These spikes in January 2021 were fueled by a forum on Reddit called WallStreetBets. In a thread on the WallStreetBets subreddit, one user explained the meme stock cycle as follows:

  • Early Adopter Phase: A handful of investors think that a particular stock is undervalued and so they begin to buy it up in large amounts. The stock’s price slowly begins to increase.
  • Middle Phase: People who are watching the market, and with a close eye on these stocks, begin to notice the increase in volume. More people then start buying, and the stock’s price skyrockets.
  • Late/FOMO Phase: Word about the stock spreads across social media and online forums. Thus, fear of missing out (or "FOMO") takes hold, and more retail investors join in.
  • Profit-Taking Phase: After a few days, buying peaks and the people who got in the game early on begin cashing out. Just like the buying phase, the selling phase becomes a chain reaction as people fear losing money. This is the moment when the price starts to go down.

Because of this cycle, it’s the early adopters who really profit from these trending stocks. Once the meme stock cycle enters into the FOMO phase, it’s most likely too late to make a profit.

Reddit is a community platform where people around the world can write whatever they please. While there are rules to prevent things like inciting violence or illegal trades, these are not enforced across the board. Keep this in mind when reading content on its many forums and threads.

“Who do I think will suffer the most?” Lynch asked. “Probably the investors that buy shares of GameStop at the top and are last to the party. Once it reaches the dinner table in most homes in America, the people who will profit the most have been in the whole way up.”

Notable Happenings: GameStop

GameStop became perhaps the most publicized meme stock in January 2021 when its price spiked hundreds of dollars in a matter of days. Users on the subreddit WallStreetBets began buying GME after they learned a hedge fund had shorted the stock

Let’s take a look at the surge. At the start of January 2021, GameStop’s stock (GME) was priced at $17.25—a price that stayed in a steady range for all of 2020. Then, just about 20 days later, GME’s growth spurred by hype online became clear: On Jan. 26, GME had reached $147.98 to close the day, up from $76.79 the day before and just $39.36 one week earlier.

Also on Jan. 26, Tesla CEO Elon Musk tweeted a link to the WallStreetBets subreddit where talk of GME was the main topic of conversation, with the caption, “Gamestonk!!” Often in the case of recent meme stocks, the cycle has been fueled by praise and mentions from public figures.

Just a day after the tweet from Musk, the stock rose to new heights once again. The price of GME more than doubled to $347.51 on Jan. 27. Then on Jan. 28, the stock reached a high of $483, before dropping to close the day at $193.60.

Short selling is when an investor—often an institutional investor like a hedge fund—borrows a stock and sells the shares with a plan to buy it back later to return. When someone shorts a stock, they’re betting the stock price will go down between the time they sell and repurchase the stock.

Lynch explained shorting a stock with a simple example: It’s like what would happen if she sells her husband’s Nike Jordans to someone for full price, with the intention to buy them at a lower price from the outlet mall and pocket the profit.

Except in the case of GME, the hedge fund’s plans went wrong as so many retail investors started buying.

“Like if I went to the outlets to buy a pair of Jordans to replace the ones I borrowed, and they weren't there,” Lynch said. “Now I'm over on eBay and get in a bidding war because they are now the hottest pair of sneakers around. The hedge funds will need to close the position and buy the stock for the new market value, even if it isn't worth it. The people in the forums that are orchestrating this are telling others to go buy GameStop—not because it is a good long-term investment. They want to beat the hedge funds at their own game.”

As you might expect, the GameStop saga attracted quite a bit of legal scrutiny. The House Financial Services Committee and the Justice Department both took a deeper look at events that led to this surge. Major brokerages, such as Robinhood, that average investors used to engage in this trading frenzy, chose to restrict trading in GME and some other meme stocks. Robinhood’s CEO said the restrictions were to help the brokerage meet increased regulatory deposit mandates. 

Plus, the entire event has caused suspicion of Wall Street strategies, as well as the ethics of the relationship between traditional financial markets and current investors.

What It Means for Individual Investors

One visible outcome of the meme stock saga has been an increase in interest in retail investing. Despite the actions of Robinhood and other brokerage firms, new downloads of those apps skyrocketed after the events surrounding the GameStop stock. The Robinhood app alone was downloaded more than 1 million times in the last week of January, when the stock surged and then later declined, according to a number media outlets, including Barron’s. 

Such an increase in retail trading activity also prompted the SEC to issue an investor alert. The alert warned people about the risks of investing in a “hot stock” or “short-term investing based on social media.”

There is no doubt that it can be exciting to make money on day trading and to be a part of something bigger, such as in the case of the GameStop surge. And yet, studies have shown that even the most experienced of day traders lose money. So while it might be a positive thing that these meme stocks have increased interest in the stock market, in the end, experts recommend following a much more prudent investing strategy.

“The biggest piece of advice that I would offer individual investors is to invest for the long term,” said Elizabeth Westendorf of Atwood Financial Planning in an email to The Balance. “Don't chase short-term profits; aim for long-term growth. Additionally, remember that if you’re saving money in a retirement plan, you’re already investing! Focus on building up those investments rather than chasing the latest fad. Investing should be boring—that’s a sign that you’re doing it right.”

Key Takeaways

  • A meme stock is a security that has seen an increase in trading volume after going viral on social media or an online forum.
  • Meme stocks have become increasingly popular due to a Reddit page called WallStreetBets.
  • The popular meme stock GameStop (GME) saw a massive price surge in late January 2021 after retail investors tried to take on a hedge fund that had shorted the stock.
  • While meme stocks increase individual interest in the stock market, experts recommend a more diversified, measured approach to investing.