Yahoo Finance Hard earned truth: Meme stocks won’t make you rich
If gambling or making speculative bets is your idea of how to get rich quick, then you’re prone to mob mentality and pack behaviour.
Fuelled by greed, or emotional triggers, or simply the fear of missing out, these sentiments are what contributed to the rise of meme stocks, which are simply stocks whose trading activity is pumped up on social media platforms like Reddit, X and YouTube.
Meme stocks often gain cult-like popularity with some investors, who often focus on just one or two in the hope of making a fast fortune.
Meme stock trading makes markets less effective at pricing
Over the past 30-plus years, financial markets have become less informationally efficient in the relative pricing of common stocks. In fact, Clifford Asness, managing principal at AQR Capital Management in Greenwich, Conn., writes in a September research paper titled, The Less-Efficient Market Hypothesis that meme stock trading makes markets less effective at accurately pricing stocks and that this decrease is particularly noticeable over medium-term investment time horizons of 10 to 15 years.
And while low interest rates played a part in this investing phenomenon, Asness stresses that technology, gamified 24/7 trading on your phone, and social media — which he argues turns independent crowds into “co-ordinated clueless, even dangerous mobs”— are the main culprits.
The popularity for meme stock investors all comes down to the fact that such investing looks playful and feels like a game or shared experience.
Meme stock investors use tweaked images, videos and text to spread positive reviews of such stocks throughout the internet. They use playful language and inside jokes when discussing their stocks and the huge stock swings add to the excitement.
But the bottom line is that it’s difficult to grow your money doing trading meme stocks. In fact, losses are much more common. Said one Reddit meme investor, “Some of these people will get rich quick, and I’m happy for them. I dipped my toes back into the blood infested waters of memes today, but then quickly remembered why I don’t anymore. Went from $500 to down almost ($3,000) in 15 minutes … escaped at a $1,250 lost and considered myself lucky. … I just can’t stomach that kind of volatility anymore, it’s too hard on my psyche.”
Still, the trend is nothing new and continues to gain popularity. In fact, meme-like trading first emerged in the 1990s with the onset of the internet and chat groups, where stocks like Blackberry were trading targets.
The role of social media in meme stocks
The term ‘meme’ surfaced in 2020, on one of the most popular platforms, known as r/WallStreetBets (WSB) on Reddit, a social news network, where a large group of users share stock tips, make predictions, engage in contests and share trading experiences.
The WSB group now has millions of users. If you go to the site you will see hundreds of messages about purchases and trade opportunities — and plenty of bragging about individual trade successes. Some of the ideas are pretty wild, although, in fairness, the site does have rules that include no advertisements, self-promotion, fundraising or bragging, no market manipulation, and your gains and losses must be realized if you want to talk about them.
The popularity of trading meme stocks started in the summer of 2020 when most people were stuck at home during the first few months of the pandemic. Making a bit of extra money with their time was appealing. The result? Extreme stock price volatility not necessarily tied to a company’s actual value or underlying fundamentals.
Instead, meme stock popularity is driven by online emotion and sentiment. They include stocks like GameStop Corp., the world’s largest video game seller, but an unprofitable company. It went from $15 a share in 2020 to $483 a share in January, 2021. Its price fell to around $40 a share within a month due to a short squeeze, or trading strategy that triggers rapidly rising prices in a stock, squeezing out those who bet against it. Today, GameStop trades at $21.
Vocal online commentators often play a key role in the hype.
In GameStop’s case, Roaring Kitty, whose real name is Keith Gill, played a pivotal role in the stock’s short squeeze in January, 2021.
Short squeeze explained
A short squeeze happens when a stock has lots of investors betting on its price to fall (short sellers). It starts when the price of a stock jumps higher than expected, and gains momentum as a huge number of short sellers decide to cut their losses and sell their money-losing shares.
Gill promoted the stock and built momentum as Roaring Kitty on YouTube and also weighed in on Reddit’s r/WallStreetBets forum. His analysis gained traction among investors as a huge number of short sellers decided to cut their losses and sell their money-losing shares.
While Gill clearly loomed large over the meme-stock landscape, you never know who the next celebrity meme cheerleader will be.
All of this translates to extreme price volatility for meme stocks that is not necessarily tied to the company’s actual value or underlying fundamentals.
The popularity is driven by online emotion and if you get the timing wrong — or if you don’t have the capital to make large bets on these stocks — it’s unlikely you’ll make money.
That was the case with home-goods retailer Bed Bath and Beyond Inc., which experienced huge volatility during a meme stock frenzy in 2022. The stock surged 314 per cent during the summer of 2022, quickly crashed back down, eventually leading to the company’s bankruptcy in 2023.
“Highs are higher and lows are lower with meme stocks,” says John De Goey, a portfolio manager with Designed Securities Ltd. in Toronto. “As such, you’re more likely to get rich if you get it right, but you’re also more likely to lose your shirt if you don’t.”
Since 2021, several regulatory actions and investigations have been started in response to the meme stock phenomenon.
The Securities and Exchange Commission (SEC) has monitored meme stocks and related trading activity. It has also been investigating patterns and potential market manipulation in markets, examining social media posts, trading dates, and broker-dealer practices to identify any illegal activities.
A case in point is Robinhood Financial, a popular trading app, which faced a major backlash and attention from regulators for restricting trading on certain meme stocks during highly volatile periods. Its penalty was US$70 million in regulatory fines in 2021, mainly for “widespread and significant harm,” to customers and misleading its customers, causing them to lose millions of dollars.
The downside of meme stocks, especially for small investors, quickly becomes apparent since the risks largely outweigh the upside.
“Let’s look at this from a positive lens first, where the meme stock pops, and you can cash out generating profits,” says Zachary Diaz, a junior investment analyst with 5i Research Inc.
Meme stocks are not meant to be held for long periods
“The key thing is cashing out. Meme stocks are not meant to be held for long periods of time, so they are not an efficient vehicle to preserve wealth and it almost undermines the goal of investing as a way to preserve and grow capital.”
Diaz goes on to explain that timing the market is one of the most difficult things to do. So, as a small investor, it makes more sense to go with lower risk options that, with time, can generate significant returns while preserving your capital.
The biggest problem with meme stocks is the high likelihood that the stock tanks and investors lose the majority of their capital. From a small investor’s perspective, these losses will be more significant because the meme stock will likely be a larger position size compared to a larger investor who has more holdings.
And for everyone who wins big, there is another who is stuck holding the hot potato. Few trade memes for the long term. And one Reddit meme investor echoes the sentiments of many: “I plan on buying more boring dividend stocks after I sell my crypto and meme stocks. I’ve made some good decisions with my play-around money but you can’t win everything. It takes a huge amount of resolve to take your loss and move on.”
And while Diaz acknowledges that luck and herd mentality can lead to some investors making money, this seldom happens for small investors. For most investors, the tried and true approaches to sound investing for the long term include passive investing in low-fee exchange traded funds (ETFs) or investing in solid blue-chip stocks that have sound fundamentals and a track record of preserving wealth.
“It makes more sense to go with lower risk options that with time, can generate significant returns, while preserving initial capital,” says Diaz.
