What is a meme stock and should you invest?

Meme stocks explained.

What is a meme stock?
Meme Stocks

If you have been keen on stocks this and last year, then you probably have noticed some dominant phrases like “meme stocks” and “meme stock”. We are going to explain what a meme stock is and discuss why meme stocks continue to send shockwaves in the market.

What is a meme stock?

A meme stock is a company whose share price is driven by social media interactions rather than fundamental performance. Meme stocks experience a rise in trading volume due to social media hype on platforms like Reddit and Twitter.

The stocks are composed of both small companies that promise huge growth and blue-chip stocks that could be potentially undervalued. Therefore, you cannot classify meme stocks based on their prevailing market value, dividend history, or price-earnings ratios.

Any stock classed as either a dividend king, a mega-cap, or deep value stock could potentially become a meme stock if retail investors target it on social media platforms.

For instance, AMC Entertainment Holdings Inc. (NYSE: AMC) is valued at over $22 billion. Another meme stock GameStop Corp (NYSE: GME) has a market cap of $17 billion while Palantir Technologies Inc. (NYSE: PLTR) is valued at $45 billion. All these are large-cap stocks. An example of a smaller company that joined the meme stocks list is KOSS Corporation (NASDAQ: KOSS), which is valued at about $205 million.

The meme stock cycle

Meme stock prices are primarily driven by speculation on social media platforms. However, that’s not how the price spike starts. In most cases, the rally starts normally with a few investors buying the stock based on the company’s performance.

First phase: In this phase, some investors start to buy shares of the company expecting a significant rise in the stock price. The decision to buy is primarily based on the company’s performance or the promise of significant growth.

A good example, in this case, is AMC stock. Shares of the movie theatre company started to rise slowly after the Center for Disease Control and Prevention (CDC) on 13th May 2021 released a statement saying fully vaccinated people could mingle in public places without wearing masks. The bullish outlook had started after theatres around the world re-opened and increased screen capacities earlier in the year.

Therefore, there was genuine fundamental backing at the beginning of the AMC stock price rally when it rose 104% between 14th May and 27th May 2021.

Second phase: In this phase, retail investors pick up on meme stocks. Increased interaction on social media platforms— generally bullish on the company, pushes the price to record highs, overvaluing the stock.

In the case of AMC, this happened between 28th May and 2nd June 2021 when the price rose from about $26.00 per share to about $62.00.

Third phase: This is the profit-taking stage when there are more investors looking to sell than those looking to buy. Inexperienced traders often buy meme stocks when they are at their peak.

AMC stock went through this phase between 2nd June and 8th June 2021. AMC shares fell by 12% during this phase.

Fourth phase: This is the stage where more investors sell off their stakes and shift to another meme stock. The stage is characterised by further declines in the stock price.

AMC shares are currently going through this phase. The stock has fallen by a further 21% since 8th June. Meme stock investors have recently turned their eyes to Clover Health Investments Corp (NASDAQ: CLOV) which rallied 135% on Tuesday through Wednesday morning. Clover Health appears to hit the third phase on 10th June recording a decline of 16.79%.

Should you invest in meme stocks?

There is no defined strategy for investing in meme stocks. Wall Street investors compare meme stock trading to gambling, which illustrates the level of risk traders could be exposing themselves to. The price swings are huge and could result in significant losses if the swing goes against your price prediction.

Therefore, it is better to focus on more defined investment strategies like investing through ETFs, Mutual Funds, or using Robo-advisors. They have proven track records and consistency in turning profits for investors. Although the returns may not be high, they are more reliable than speculating using meme stocks.

Bottom line

In summary, meme stocks can result in massive capital gains over a short period. The challenge here is timing. If you arrive late to the party, you could make significant financial losses. If you are among the early investors, you could be one of the biggest beneficiaries of the price swing.

Meme stocks have been a revelation to retail investors. They have also attracted criticism from Wall Street investors with the likes of Jim Cramer repeatedly citing their overvaluation. Cramer recently warned investors about Clover Health’s overvaluation. But meme stocks have survived to date and it seems they are here to stay.

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