What is a meme stock and why are they popular?

What is a meme stock?

A meme stock refers to a publicly-listed company that has grabbed the attention of retail traders and is stirring discussed on social media forums. Hype is created on these forums and fuelled by rumours, speculation, and theories – many of which ignore what can often be flawed fundamentals.

Meme stocks and the Reddit trading frenzy

The introduction of simpler and cheaper trading apps has encouraged more people to engage with the stock market in recent years. In fact, individual US investors went from accounting for less than 15% of equities trading volume in 2019 to over 25% during the trading frenzy in 2021.

That was when retail investors and traders realised their potential power by forming a loosely coordinated strategy on the WallStreetBets forum on Reddit to buy shares and out-of-money call options on stocks that were being targeted by short sellers such as GameStop and AMC Entertainment in an attempt to push the price higher.

The idea was to create a short squeeze. A short squeeze does what it says on the tin – it tries to squeeze short sellers out of their positions. Short sellers, mostly big institutional investors and hedge funds, bet that the price of a stock will fall but, as retail investors pile in and push the share price higher, they are forced to start buying the stock to try to limit their losses. The buying by the big players only fuels the share price higher.

Most meme stocks are high risk, volatile and often have a significant flaw. However, retail traders appear keen to back companies that are trying to turn things around in the hope of booking a profit. For example, GameStop is trying to turn itself from a bricks-and-mortar retailer of video games into a digital giant built around everything from gaming to Non-Fungible Tokens (NFTs), while AMC Entertainment’s management have been the most receptive to the support shown from individual investors as it tries to recover from the pandemic and branch out into new areas.

This, unsurprisingly, makes many meme stocks a prime target for short sellers that look for failing companies to bet against. In turn, those short sellers have then been targeted by the retail horde. Stocks with rising short interest tend to attract retail traders looking for the next potential short squeeze. That allows them to try to profit while also providing a kick to the institutions that profit from a company’s failure through short selling practices. That has created what can be described as a ‘David vs Goliath’ battle.

The result? Well, we saw GameStop’s valuation soar from around $1 billion at the end of 2020 to over $22 billion by the end of January 2021, while AMC Entertainment went from less than $500 million to a staggering $28 billion during the first six months of 2021. This demonstrates the extreme volatility on offer from meme stocks, with both GameStop and AMC’s valuations today at roughly halve where they sat at their peak.

How to trade meme stocks

For many, meme stocks are the weapon of choice for first-time investors. Unfortunately, this can feel like diving into the deep end for many given the volatile nature and level of risk attached to most meme stocks.

Social media threads, particularly popular ones like WallStreetBets, are a key tool for retail traders looking to find out what stocks are grabbing attention and why. These can be used to filter out noise and try to find compelling strategies or tips.

Once you have identified potential meme stocks you want to trade, consider why they are being discussed. Are they simply undervalued? Is there a potential short-squeeze? Is it pursuing a turnaround plan that offers an opportunity? It is crucial to understand what you’re getting yourself into.

With this in mind, short data can be a useful tool to help identify the most heavily shorted stocks that could be ripe for a short squeeze. Outlets such as S3 Partners have become a widely used source of short interest data. Any meme stock that is in play but not being intensely targeted by short sellers is likely to be grabbing attention because retail traders perceive them as undervalued.

From there, you need to research the meme stocks you are interested in. Although the extreme valuations that some meme stocks have earned completely ignore the fundamentals, it is still important to get your head around the business and know what you’re trading. Some retail traders love the simplicity of trading a meme stock undergoing a short squeeze can offer, as a short-term bet requires less attention to the fundamentals. But it is important to comprehend what drives the business, especially in the case for long-term believers invested in the likes of GameStop and AMC. If you’re in for the long run then this is essential, especially given the risk of being caught out by any sudden movements.

Once you are comfortable with the meme stocks you want to trade, its time to consider your strategy and level of risk. Are you going long or short, and are you speculating over the short-term or the long? What level of risk are you willing to take on? What’s the maximum loss you are willing to take? What sort of profit would prompt you to exit? How much money from your wider portfolio are you willing to funnel into riskier meme stocks? These are just some of the questions worth asking yourself as you prepare to enter the fast-moving world of meme stocks.

What are the biggest meme stocks?

The loose definition of meme stocks and their volatile nature makes it difficult to rank them by size, but there are numerous companies that have remained popular since they became a thing back in 2020. GameStop and AMC Entertainment are widely accepted to be the two original meme stocks.

Other meme stocks that have consistently stirred discussion online in recent years include homeware retailer Bed Bath & Beyond, Big Data outfit Palantir, space firm Virgin Galactic, financial services provider SoFi and AI lending platform UpStart. Robinhood – the trading platform at the heart of the original trading frenzy in 2021 – has also become a meme stock.

Top meme stocks: What will be the next meme stock?

It is not uncommon for individual meme stocks to fall in-and-out of favour. Fortunately, we publish the 10 most-discussed stocks on WallStreetBets every day to keep you up to date on the latest meme stocks that have fallen under the spotlight and why they are in focus.

You can read the latest one in Reddit Stocks: What Meme Stocks are Trending?

It is important to note that not all the most actively discussed stocks on Reddit are struggling or being targeted by short sellers. Many of the most mentioned stocks, like Apple or Tesla, are simply popular among the community.

How to go long and short on meme stocks

You can trade a variety of meme stocks with City Index in just four easy steps:

Open a City Index account, or log-in if you’re already a customer.
Search for the stock you want in our award-winning platform
Choose your position and size, and your stop and limit levels
Place the trade

Or you can try out your trading strategy risk-free by signing up for our Demo Trading Account.

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