Is Investing in Meme Stocks a Good Idea?

In recent years, Wall Street has seen the meteoric rise of "meme stocks"—securities that gain rapid popularity and trading volume because of their viral nature on social media and online forums.

From GameStop (GME) to AMC Entertainment (AMC), these volatile stocks have captured the attention of retail investors and financial markets alike. But what exactly are meme stocks, and is investing in them a wise financial move?

Understanding Meme Stocks

The term "meme stock" is a relatively new addition to the investment lexicon, emerging in the wake of the GameStop trading frenzy of early 2021. However, the concept of stocks spiking suddenly in popularity and trading volume from social media buzz and online investor communities has been around for longer.

The meme stock phenomena can be traced to the rise of commission-free trading platforms like Robinhood (HOOD) and the growing influence of online forums such as Reddit's r/WallStreetBets. In 2021, as many were at home due to pandemic-era lockdowns, the time and free trading available set the table for what followed.

In the past, stocks like Tesla (TSLA) or crypto assets like Bitcoin have exhibited meme-like characteristics, with their prices often swayed by social media sentiment and online discussions. However, the GameStop saga of early 2021 brought the concept of meme stocks into the mainstream.

In January 2021, the stock of GameStop, a struggling brick-and-mortar video game retailer, surged to a peak of several hundred dollars per share in a matter of days. This unprecedented spike was primarily driven by activity on the r/WallStreetBets subreddit, where retail investors banded together to buy the stock en masse and squeeze short-sellers who had bet against the company. However, regulators later examined various trading platforms, concerned they had boosted trading during the craze.

What Defines a Meme Stock?

The GameStop phenomenon highlighted several key characteristics that have come to define meme stocks:

1. Viral popularity: Meme stocks gain traction through social media platforms, online forums, and messaging apps. The buzz surrounding these stocks spreads rapidly, drawing in an army of retail investors.
2. Collective action: Meme stock investors often coordinate their buying and selling efforts, creating a sense of shared purpose and community. This collective action can lead to significant price moves, herding behavior, and market volatility.
3. Disconnect from fundamentals: The prices of meme stocks often become quite detached from the company's underlying fundamentals. Instead, trading is driven by social media sentiment, fear of missing out (FOMO), and the potential for rapid gains.
4. Large short interest: Many meme stocks have a high percentage of their shares sold short, meaning that investors are betting on declining stock prices. This sizable short interest can fuel a phenomenon known as a short squeeze, where a rapid increase in the stock price forces short-sellers to buy back shares to cover their positions, increasing demand and further driving up the price.
5. High volatility: Meme stocks are known for their extreme price swings, with sudden surges often followed by steep declines. This volatility is fueled by the speculative nature of the investments and the emotional reactions of investors.
6. Retail investor-driven: Meme stocks are heavily influenced by the actions of retail investors, rather than institutional investors or traditional market forces. The collective power of these small individual traders can significantly impact stock prices.
   

Since the GameStop event, other stocks like AMC Entertainment, BlackBerry, and Bed Bath & Beyond (BBBY), among others, have also been caught up in the meme stock frenzy. The phenomenon has drawn attention to the growing influence of retail investors and the power of social media in shaping financial markets.

However, it is important to note that while meme stocks offer the potential for rapid gains, these are generally, as later investigations made clear, far outweighed by the risks to most investors. The speculative nature of these investments, combined with high volatility and the potential for market manipulation, makes them unsuitable for anyone but traders with knowledge about what's happening in the moment and experience to act on it.

The Communities Formed Around Meme Stocks

Meme stocks arose from a unique investment subculture characterized by a strong sense of community, solidarity, and a shared identity among retail investors. This culture is primarily fostered through online forums, social media platforms, and messaging apps, where investors gather to discuss stocks, share research and opinions, and coordinate their investment strategies.

At the heart of this community is a sense of camaraderie and a desire to level the playing field against institutional investors and traditional Wall Street firms. These retail investors see themselves as underdogs taking on the financial establishment. Many share the goal of driving up the prices of meme stocks, causing losses for hedge funds that have shorted these stocks and profiting from the ensuing volatility.

The language and humor used within these communities are often irreverent, self-deprecating, and filled with inside jokes and memes. Members use a mix of financial jargon and internet slang, with terms like diamond hands (holding a stock despite market fluctuations), "tendies" (profits), and "to the moon" (expecting a stock price to rise significantly) becoming part of the everyday lexicon. These communities have also developed a strong sense of loyalty and mutual support. Members often encourage each other to hold their positions, even during market downturns or negative news. HODL (a misspelling of hold) has become a rallying cry, urging members to maintain their convictions in the face of adversity.

The sense of community and shared purpose among meme stock investors has also led to a blurring between investing and social activism. In some cases, investors have framed their actions as a form of protest against the perceived inequalities and corruption of the financial system. The GameStop saga, for example, was seen by many as a way to punish hedge funds for their predatory short-selling practices.

The Troll Factor

It's worth highlighting that central to the meme stock phenomenon is a mix of populism, defiance of elites, ironic detachment, and sheer entertainment value—that is, trolling. Investors taking part might buy specific stocks not only for potential gains but also to challenge traditional market norms, spite short-sellers, or simply for the entertaining narrative surrounding the stock.

For example, in the case of BlackBerry, some investors may have been drawn to the stock as an ironic way to support a company that had become largely irrelevant in the smartphone market. Despite BlackBerry's steep decline since its Obama-era popularity, retail investors rallied around the stock, partly because of the supposed comedic value of investing in a company whose devices were considered outdated relics. This troll-like behavior adds even more unpredictability to the meme stock phenomenon.

Risks and Considerations

Not everyone is amused. Critics argue that the meme stock culture promotes groupthink and a herd mentality, leading to a disregard for fundamental analysis and a focus on short-term gains over long-term value. The echo chamber of these online communities often amplifies confirmation bias and leads to the spread of misinformation or conspiracy theories.

Despite these concerns, meme stock investors' sense of community and shared identity remains a powerful force. As social media continues to shape how people interact and share information, this culture will likely evolve while influencing the world of investing—creating exceptional risks for investors willing to engage.

Volatility and Market Manipulation

While meme stocks offer the potential for sudden, significant gains, they also come with significant risks. The rapid influx of investment and sudden price surges are often followed by equally swift declines, leading to large losses if you bought on the way up. In addition, the viral nature of meme stocks makes them susceptible to market manipulation, as coordinated buying or selling efforts can artificially inflate or deflate prices. Indeed, there have been enforcement actions brought by the U.S. Securities and Exchange Commission (SEC) after various meme stock events.

For example, GameStop underwent new periods of volatility in 2024, driven in part by the actions of influential figures within the meme stock community. In June 2024, Keith Gill, also known as "Roaring Kitty" on Reddit, posted a series of memes on social media along with a screenshot of his GameStop position, revealing a large bullish position. Gill, who became a celebrity among GameStop investors during the first meme stock frenzy in January 2021, saw his post go viral with millions of views.

Following Gill's post, GameStop's stock price surged by nearly 50% within a day as retail investors rushed to buy shares and ride a new wave of enthusiasm. This raises questions about the potential for market manipulation within the meme stock community. While Gill's post may have genuinely reflected his belief in GameStop's prospects, the outsized impact of his social media activity on the stock price highlights the power that influential figures can wield in this space.

Investment Risks

A striking disconnect between the share price and company fundamentals often defines meme stocks. This means the company's financial performance, growth prospects, or market position do not justify the stock price. Instead, the price is driven by hype, collective enthusiasm, and speculation—not a careful assessment of the company's intrinsic value.

This disconnect makes meme stocks inherently risky for long-term investment decisions. When the price of a stock is not tethered to the company's fundamentals, it becomes considerably more challenging to predict future performance and to make informed decisions about when to buy, hold, or sell. Essentially, it's far closer to gambling than investing.

Then, as is almost always the case, when market prices eventually fall in line with long-term fundamentals, investors who bought at the peak may face significant losses.

Regulatory Concerns

The flurry of trading surrounding meme stocks has drawn the attention of regulators and lawmakers. The SEC still has concerns over potential market manipulation and the need for increased oversight given the meme stock phenomenon. In some cases, trading platforms have restricted or halted trading in meme stocks to manage risk and follow regulations. In others, social media influencers, such as Roaring Kitty, have been investigated for being on the wrong side of securities laws.

GameStop and Gamification

In a twist of irony, GameStop—a company known for selling video games—became the centerpiece of a phenomenon that highlighted concerns about the gamification of investing itself. The GameStop saga, while driven by social media, was also fueled by trading on gamified trading platforms that could amplify market trends, turning stock trading into a viral, gamelike experience that spread rapidly through social media. As was reported in 2023, the SEC has stepped up efforts to better regulate the market.

In recent years, across various sectors, app makers and management companies have been incorporating "gamification" or "digital engagement practices" (points, rewards, and gamelike features) into employee training and more. Many trading apps now include social features that allow users to share trades or follow other investors, mirroring the community-driven nature of the meme stock movement on platforms like Reddit.

In the abstract, some researchers point out how "gamification" can be used, with behavioral finance principles, to nudge investors toward better behaviors. But investors aren't speculating using apps in the abstract; they are investing through broker platforms whose gamification nudges are for increased trades, not to push retail investors toward the best long-term trades—which, by definition, would lead to a decrease in trading, not more.

Gamified features like push notifications about price movements or popular trades can trigger FOMO, potentially driving investors to make impulsive decisions, as seen during the meme stock boom. While these platforms have made investing more accessible, the meme stock event highlighted how this accessibility, combined with gamelike features, could lead to heightened volatility and risk-taking among inexperienced investors.

"My primary concern with gamification is its potential to induce trading that is more frequent or higher-risk than an investor would choose" otherwise, said Rick Fleming, the SEC's former investor advocate.

For Fleming, gamification muddied the distinctions that SEC regulations, including Regulation Best Interest (BI), 2020, take as clear, namely the difference between solicited (recommended by brokers) and unsolicited (initiated by the client) trades. For solicited trades, brokers are typically required to ensure the recommendation suits the customer. During much of the meme stock period of the early 2020s, the requirement was less stringent for unsolicited trades: unsolicited trades were to be "suitable," not in the clients' "best interest." "Brokers' obligations under Reg BI should not turn on whether the customer technically initiates the trades after the broker has used subtle techniques to influence the customer to engage in active trading, trade on margin, trade options, and engage in other risky practices," he said. This is why, as we reported in 2023, the SEC amended regulation BI to ensure it covered the predictive algorithms behind gamified investment apps.

The meme stock phenomenon brought these regulatory challenges into sharp focus. Features like confetti animations for completed trades, prominent during the GameStop frenzy, brought home worries that such design elements induced too much risky investor behavior.

Investment Strategies for Meme Stocks

Given meme stocks' viral and nonfundamental nature, it is crucial to conduct thorough research and due diligence before investing. This includes examining the company's financial health, competitive landscape, and growth prospects, as well as understanding technical analysis. While social media buzz can be tempting, basing investment decisions only on online hype is not a wise approach to trading.

If you still want to get involved in the meme stock craze, monitor your positions closely and in real-time. Set take-profit and stop-limit orders, knowing that any upside potential may be short-lived. Determine how much you'll invest and can afford to lose, and stick to those boundaries. It's also wise to have a defined exit strategy to manage risk and protect profits, such as setting price targets or stop-loss orders.

Meanwhile, a short-term meme stock strategy should fit your overall market strategy. In this case, it should suit only those with a high-risk tolerance. You'll want to ensure you don't exceed your specified allocation to meme stocks; holding several meme stocks is not diversification since their prices tend to be highly correlated.

The Bottom Line

Trading meme stocks is akin to riding roller coasters for adrenaline-junkie investors, but like intense theme park rides, they're not recommended for those without the stomach or financial means to engage in such trading. The attraction of quick profits and the sense of community surrounding these stocks can be enticing, but the inherent volatility, lack of fundamentals, and potential for manipulation make them quite risky.

For investors with a high-risk tolerance, capital to spare, and a willingness to closely monitor the market, meme stocks could offer prospects for short-term gains and excitement. However, this approach requires a keen understanding of market dynamics, the ability to time entries and exits accurately, and a willingness to accept the potential for significant losses. For most investors, particularly those with longer-term goals like saving for retirement or building wealth over time, meme stocks are not a wise choice.