Meme Stocks 101

Written by Firethorn Wealth Partners

June 23, 2021

This month’s newsletter is meant to serve as an introduction as well as a foundation for understanding meme stocks. We will unwrap what is going on with the meme movement and how it can impact our clients for the foreseeable future.

What is a Meme?

A meme is a way for social media users to share an idea, trend, or certain behavior. It is a humorous image, video, piece of text, etc., that is copied (often with slight variations) and spread rapidly by internet users.

What is a Meme Stock?

A meme stock is not a “growth” or “value”stock and, honestly, there is no clear definition. A meme stock in its simplest form is a stock that sees huge price increases fueled by people on social media platforms (primarily Reddit, Twitter and TikTok). There has even been the incorporation of certain emoji and phrases such as, “to the moon” or “diamond hands” that have become popular taglines in them meme stock social media world. These stocks rarely have company fundamentals
that justify the rise in price and are often highly volatile. So why have investors and the media focused on these over the last several months?

What Drives the Price Volatility?

FOMO is one of the main reasons that investors are buying these stocks. The acronym FOMO stands for the “fear of missing out” and used frequently by the highly connected millennial and Gen Y generations.

A great example of a meme stock in 2021 was the out-of-favor, brick and mortar, video game retailer GameStop. The stock
traded around $19 per share at the start of 2021, but it had risen to an all-time high of $483 per share by the end of January 2021. That is not a misprint folks. There have been many more examples of meme stocks in 2021 such as AMC, BlackBerry, and Bed Bath & Beyond to name a few.

Should You Buy the Meme Right Now?

In our opinion, investors should not buy into the meme mania and tread very cautiously if they do decide to dive in the deep end of the pool. Part of the reason
meme stocks such as these have arisen in the first place is the FOMO discussed earlier. FOMO is fueled by too many people chatting about how much easy money they
are making on these trades. We do not consider them to be an investment but more a short-term momentum trade. These situations often start with a short squeeze and then turn into a self-fulfilling prophecy in the short run. The price of the stock will continue to increase along the way as more and more investors are willing
to bid up the price because of FOMO. The crash and bottoming out process will begin once the upward momentum runs out of buyers and stocks reverse their course.
Once this starts then look out below! These short-term momentum traders will look to exit positions as quickly as possible causing the stock to crash back down to
fundamental levels. Remember that things are often trading cheaply for a reason. Just because something is cheap does not make it a “value” stock!

Kind of Smells Like a Pump and Dump Scheme?

The Meme Stock mania and a pump and dump Ponzi Scheme are different, but they do seem to share some similarities (like Mark Twain proclaimed about the rhyming
of history). Meme stocks do not start out to defraud somebody, but they do attract unsophisticated investors who may not fully understand how markets work. The two are similar because you need either existing or new investors to continually come in and by a stock at ever higher prices. This means some investors will make money on these trades and, unfortunately, many investors will ultimately end up losing money.

If you are inclined to “trade” these stocks here are some things you should carefully consider before doing so:

  • Rocket ships will eventually burn out of fuel, and you certainly do not want to be the last one buying.
  • To make real money, you need to be one of the first to start selling, and it is very hard, if not impossible, to know when that time has come.
  • One might be tempted to short the stock or, in other words, try to make money betting that the stock will fall in price. It is extremely dangerous to sell short as the stock price no longer has any connection to the fundamentals of the company. The entire reason the price has skyrocketed is because of the amount of people on that side of the trade.
  • Many traders of these stocks claim to have diamond hands meaning they intend to hold onto the stock for the long term no matter what happens. Be cautious of this because those so called “diamond hand” traders tend to go away once the stock starts to trade down in price and those traders begin to lose money.

As always, we are here should any of the articles spark questions or comments.