Rise of meme stocks
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Meme stocks – the pincushion point where viral marketing merges with Wall Street – is creating a buzz of its own among investors across the board in 2021. Legions of retail traders, many of them young people fortified by zero commission trades and easy access to markets, are testing the limits of traditional equity trading structures as they seek quick scores via trading patterns based on viral marketing.

Some market watchers, including the regulators paid to ensure fair trading markets, see the creation of a potential monster in the elevation of meme stocks like GameStop (GME), AMC Entertainment (AMC), and Blackberry (BB), among other brand name stocks. That sentiment hasn’t dissuaded digital trading enthusiasts, and millions of investors have flocked to meme stocks.

Case in point: A new study by The Harris Poll reported that over 25% of U.S. investors said they purchased at least one or more viral stocks since the start of the new year.

Spot the Trends

The Harris survey helps clarify the meme stock narrative among investors, with these trends at the top of the survey’s list:

  • Younger men dominate. Demographically, younger men were most likely to buy meme stocks, with 40% of those ages 18-44 and 40% of men buying shares, compared to 17% of those 45-plus investors and 16% of women.
  • Investments are typically small. Investors seem to be reluctant to steer too much money into meme stocks. Harris noted that about 50% half of meme investors who purchased viral stocks in January kept their total investments in viral stocks “relatively small.” 53% of those investors invested $250 or less in viral stocks. Only 15% invested more than $1,000.
  • Trades are short term. Most meme stock investors are only in it for the short-term. “Of those who bought GameStop stock this past January, 56% also sold shares in January,” Harris reported. “Of those who still have remaining shares, a third (34%) plan to hold their position for less than a month.”
  • Social media and internet forums are the main drivers of viral stocks. The Harris survey tags social media (35%) as the leading viral stock meeting place, with Twitter a particular hot spot. Viral stock traders favor digital trading forums (32%) like Reddit’s r/wallstreetbets forum while traditional news media (31%) follow as the “top three” influences for meme stock buyers. (At the bottom of that market influencer’s list were financial advisors – only 20% of meme stock buyers purchased a viral stock on the advice of a financial advisor.)
  • Research is out of style. Meme investors aren’t as interested in doing the due diligence necessary to make stock market decisions. “Despite the national buzz around viral stocks and the broader stock market, only a third of Americans (36%) have been interested enough to study how the U.S. financial system (e.g., banks, insurance companies, stock exchanges) and markets (e.g., primary markets/IPOs, secondary markets/stock markets) work”.

Motivations for purchasing meme stocks vary. Many investors active on social media say that they aren’t interested in gains and merely wish to participate in a short squeeze targeting hedge funds. Others expect to earn a quick profit from volatile stocks. What both have in common is the use of modern trading technology and reliance on social media for communication with other traders.

Trading Technology That Fits the Younger Lifestyle

As the Harris study shows, younger investors are increasingly viewing stock trading as a natural extension of their digital lifestyles.

A major study on consumer finance issues released by Harvard College Consulting Group in January 2021, describes how digital technology has fueled interest in stock market trading among younger Americans – and has created the no-commission trades and fractional shares trading landscape that fits the lifestyle of younger investors.

“Over the past ten years, the emergence of new consumer finance technologies and businesses, such as digital-first banks, cryptocurrencies, online stock trading apps, micro-investing apps, and more, have revolutionized the consumer finance industry and enticed growing numbers of young people,” the report stated. “Plus, the prevalence of mobile banking solutions is only growing, as a Morgan Stanley survey of 6,000 consumers aged 16 to 34 in 2018 found that 47% of 16- to 17-year-olds and 71% of 18- to 19-year-olds use mobile apps to help manage their money.”

Apps Make it Easy

The study also noted that while younger Americans were only “moderately comfortable” with the stock market, the pervasiveness and low cost of mobile financial apps used by many younger investors made that trading experience easier and more cost-efficient.

“Mobile apps which had zero-commission trading and fractional-share trading, such as Robinhood, took the stock investment space by storm in 2013,” the Harvard report stated. “Robinhood had 500,000 users in its first year, and the company now reports 13 million users and over $180 million in revenue. In order to compete, companies like Charles Schwab, TD Ameritrade, Ally Invest, and Fidelity have dropped their electronic transfer fees to zero, lowering barriers to entry and making the cost much less of an obstacle to investment, especially for younger generations.”

According to the survey, Robinhood was the most widely-used investment platform with 19% of respondents having used it, followed by Fidelity Investments and TD Ameritrade. “When asked about important factors considered in their choice of investment platforms, zero-commission stock trading and fractional shares ranked as the most important factors among Gen Z respondents, 55% of whom already trading stocks.”

More Questions Than Answers on Meme Stocks

While meme stocks remain in the headlines and at the forefront of investor sentiment in early 2021, a larger question remains for investors who rely on hype rather than fundamentals to drive stock buying decisions.

Can investors really count on meme stocks as stable portfolio contributors, especially given the sources of information that push meme stocks to the front of the investment trading culture?

“There’s good and bad elements tied to viral stocks” said Asher Rogovy, chief investment officer at Magnifina, a New York City-based money management firm. “For instance, because interest rates are so low, there are fewer compelling investments. A meme stock might act as a de facto store of value so long as its forward-looking valuation is somewhat plausible. Yet mis-valued stocks might correct sharply if rising interest rates pop speculative bubbles.”

Pulling the lens back further, Rogovy believes it’s “foolish” to trust anonymous posts on the internet.

“Fraudsters may be emboldened to make false claims on anonymous internet forums,” Rogovy said. “I never fully trust any information that doesn’t come with a face and a name. On WallStreetBets, I have seen considerable amounts of demonstrably false information being posted and repeated.”

Rogovy’s quote illustrates one of the risks of the meme stock movement. Emotional drivers like the desire to squeeze a hedge fund can deliver non-financial rewards to some participants. They can also bring very real financial gains to stockholder who sell into the frenzy. That creates potential for manipulation, and where that potential exists, it will be exploited.

A Repeat of the Wild 1990’s?

Rogovy also believes the recent activity arising from WallStreetBets mirrors the late 1990’s, when independent online trading first became widespread and message boards like Silicon Investor and Raging Bull became the preferred vehicles for both information and misinformation.

“It’s just happening to a different generation,” he added. “Much of the misinformation about short squeezes has already been spread in similar events.”

Yet there are major distinctions between the late-’90s tech stock boom and today’s meme stock surge, and it’s not good news for retail investors.

“Unlike the 1990s, today’s retail millennial investor does not invest with the same sort of optimism and “irrational exuberance” that characterized the investing behavior of his or her parents’ generation,” said Demetri Kofinas, a long-time trader and host of the Hidden Forces podcast. “People buying high-flying internet stocks in the late 90’s really did believe that they were living in a “new paradigm economy” and that they were jumping on a train of transformation that was going to leave the legacy economy in the dust.”

Kofinas believes that late 1990’s investors believed they were investing in the future.

“Today’s millennial investor pouring money into Tesla (TSLA) or Uber (UBER) does share some of that exuberance, but this type of optimism is not a market-wide phenomenon, like it was in the 1990’s,” he said.

Optimal Conditions for Meme Investors

The emergence of the younger investor who is more likely to pursue viral stocks is hardly an accident. It’s the end result of dominant technology combining with a global pandemic that kept people at home and looking for online distractions. It’s up to the masses to entertain themselves during lockdown, and the Reddit-inspired investment army figured they might as well try to make a buck or two – or maybe take a whack at a short-selling hedge fund – in the process.

“The emergence of the retail investor, along with stimulus checks and extra time to work from home, is creating a breeding ground for pump and dump stocks,” said George Papazov, founder of TRADEPRO Academy, a platform that helps at-home traders and investors achieve liftoff.

While the newest generation of young traders possess its fair share of exuberance, it’s courting danger as so many younger investors have yet to grasp the downside of focusing on viral stocks.

Brains and Bulls

“There is a saying among veteran traders that says, “don’t confuse brains for bulls”, Papazov said. “When markets are moving higher at breakneck speed, due to money printing by the Fed and the inflation of paper assets, you can buy just about any stock and make money. But learning to trade one market condition doesn’t mean you can make it a career, and that’s a big risk to meme investors.”

A larger risk to viral-minded investors is not knowing how to trade through down markets, and how to navigate more challenging times. When markets are soaring across the board success comes easy, and success breeds confidence. Confidence can easily lead to dangerous overextension.

“You can’t ignore the reality of the downside, and that downside will inevitably come when everyone has spent their savings buying stocks,” Papazov added. “Once everyone has already bought, they are sellers and the market turns lower.”

“The focus on fundamentals will return in due time, but right now value investing is broken.”

What does all this mean for the average investor? Trading in volatile meme stock is certainly an option. Some people are making money doing it, but those who buy late and don’t sell in time can stand to lose a great deal. The prospect of striking a blow against “the system” is exciting, but emotion-driven traders are easily exploited by the very system they seek to upend. At the end of the day they tend to lose money, and the people who stayed calm and took calculated risks tend to gain.

Sidebar: Pros and Cons of Meme Investing

What are the potential risks and potential advantages of meme stocks both for the markets as a whole and for individual investors? Trading experts have some ideas on that front.

Advantages

👉 People start investing who normally wouldn’t have. “Investing becomes exciting, opportunistic and even to some extent addictive,” Papazov said. Robinhood played a big part in this, gamifying the entire experience and making it too simplistic.”

👉 Younger investors are comfortable with the digital stock trading experience. No doubt, memes are a form of culture and communication that is native to the Internet. “Joining a community like WallStreetBets or tweeting about dogecoin is a way of participating in a community with its own culture and language,” Papazov said. “Memes are how that culture spreads and the creativity, salience, humor, and artistic intelligence of a community’s memes are directly tied to the strength and durability of that community.”

Disadvantages

👉 People are making amazing money but doing it with bad habits. “In the end, if you are up money and getting away with risky behavior, you have only accumulated borrowed money and it will eventually be returned,” Papazov added. “Another big disadvantage is that meme stocks deteriorate the confidence of capital markets – institutional investors worry and start to sell to take profit and hedge their risks, which creates an environment where broad markets drop while these meme stocks sustain their rally.”

👉 It gets harder to sell meme stocks. Another major problem with meme investing is that everyone is buying the same few stocks together.

“Every buyer needs someone willing to sell it to them,” Papazov said. “While meme investors can accumulate enormous positions together and run up big unrealized gains, in the end they will need to sell it to someone to get out, as the late buyers are often the ones being sold to by people who own it from below.”

“While crowd sourced investing is great for pumping prices up, eventually these same traders use each other to exit positions at their detriment,” he added. “In stock trading, ideas and analysis are better than convincing each other to buy the same stock you did – just so you can have someone to sell it to and to push your position higher.”

What are your thoughts on the sudden rise of meme stocks? Let us know in the comments section below!