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Meme stocks and how to play them

When stocks go viral, it’s tempting to jump on the bandwagon. Here’s what you need to know before you buy in.

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Kliment Dukovski
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Add together mobile apps with free access to the stock market, a stimulus check and people locked in their homes for months with limited entertainment options — and you get meme stocks. But what started as a fun way to pass the time turned into a movement that shook the stock market early this year and continues to drive a lot of stocks today.

How meme stocks work

Meme stocks are ones that quickly go viral online and draw the attention of retail investors. This typically starts on social media sites such as Reddit, where someone posts information about a stock — whether it be undervalued or heavily shorted. As other investors pick up the information and start buying, the stock price starts to rise.

Lifecycle of a meme stock

When a company reaches meme stock status, things start to change. Here’s how it usually goes.

1. Early adopter phase

A few investors post about a certain company and why they consider it a good investment. Other traders start to pick up on this, upvote the comments — which gives them higher visibility — and start accumulating shares at the current price level.

2. Middle phase

More people notice the stock. As they start buying, the price goes even higher. At this point, you may see more posts about the company as a good buying opportunity on social media as commenters debate its fate.

3. Late/FOMO phase

By now, the stock price has already skyrocketed and it’s caught by the mainstream media. More people start buying because of fear of missing out (FOMO). This drives the stock price even higher.

4. Profit-taking phase

Those who bought the stock first now start unloading all their shares — or some of them. This causes the stock price to slide. Sophisticated investors, hedge funds and large financial institutions may now start to short-sell the stock — borrowing the stock to sell it at the high price with the hope of buying it back at a lower price, pocketing the difference.

As more people sell the stock to earn a profit, the price drops. Some of those who bought late are now losing money and panic selling, thus lowering the price further. Eventually, the stock price reaches either its starting point or slightly higher.

The exception here is if some people refuse to sell the stock, having decided they like the company behind it. This happened with GameStop and AMC Entertainment, where their stock prices pulled back from the peak but still remained much higher than before they got the meme stock status.

Advantages and disadvantages of meme stocks

Investing in the right stock at the right time can be extremely profitable. But it’s not always easy to find such a stock. Here’s what you need to be aware of before you buy into a meme stock.

Pros of meme stocks

  • Quick reward potential. If you get in before the crowd and you’re right about the stock, you could see massive reward potential in a short time.
  • Find excellent companies. Some companies that get the meme stock status can be excellent long-term investment options.
  • Unique learning experience. Not only do you get to see which stocks can earn you money, but you can also learn about investing and even options trading as you read what other traders and investors are doing. This is slightly different from how you would learn it about traditional stocks, mostly because of the higher risk/reward ratio of meme stocks.

Cons of meme stocks

  • Riskier than traditional investing. You never know who is behind a Reddit or social media post. Their own interests may not necessarily align with yours. Do your own due diligence or risk losing money.

3 meme stocks to watch

While there are many meme stocks, we’ll focus on the three most popular in terms of mentions on Reddit, post upvotes and stock price movement.

1. AMC Entertainment Holdings (AMC)

AMC is a movie theater chain — the largest in the world. Because of the coronavirus lockdowns, the company lost revenue, which caused its stock price to plummet. As such, the stock was heavily shorted by hedge funds and financial institutions. Some investors claimed that these institutions were involved in naked shorting — i.e. selling short more shares than there are shares available to borrow.

Reddit traders saw this as an opportunity to fight against what is an illegal practice. That’s why many Reddit traders started buying AMC, which made it a meme stock as soon as it lifted off. This made the hedge funds borrow back the shares they were short selling at a way higher price, making them lose more than 5 billion. In January 2021, the stock jumped almost 900%.

  • Market cap: $19 billion (as of November 2021)
  • Recent stock price: $35
  • Dividend: N/A
  • 1-year return: 1,624%
  • 5-year return: 18%

2. Tesla Inc (TSLA)

Tesla is an electric vehicle manufacturer. It didn’t have as rough a time during the pandemic as AMC. But it’s led by Elon Musk, who posts memes on Twitter, supports Bitcoin and other cryptocurrencies and has made Tesla one of the most popular electric vehicle manufacturers. This caught the attention of the Reddit community and quickly became a meme stock.

On Reddit and the WallStreetBets subreddit, Tesla often has more than 5,000 upvotes and around 700 mentions in a 24-hour period. No other company even comes close.

  • Market cap: $1.1 trillion (as of November 2021)
  • Recent stock price: $1,114
  • Dividend: N/A
  • 1-year return: 178%
  • 5-year return: 2,823%

3. Bed Bath & Beyond (BBBY)

Bed Bath & Beyond is a chain of domestic merchandise retail stores. This company was among the first meme stocks that were heavily shorted by hedge funds. With retail traders jumping in on the stock, the price gained almost 200% in January 2021 alone. After that, the stock price returned nearly to pre-meme-stock levels.

In early November 2021, the stock jumped 44% in just a few days when it announced the launch of a digital marketplace in partnership with grocery giant Kroger, plus a $1 billion share buyback program, which is ahead of schedule.

  • Market cap: $2 billion (as of November 2021)
  • Recent stock price: $19.80
  • Dividend: N/A
  • 1-year return: -5.64%
  • 5-year return: -48%

Investing in meme stocks

Here’s how to invest in meme stocks.

  1. Go to Reddit and in particular WallStreetBets. You can also use our trending stocks on Reddit page as a guide.
  2. Read the threads to find a stock you may want to invest in.
  3. Research the stock to see if it’s worth buying.
  4. Log in to your brokerage account or open an account if you don’t have one.
  5. Enter the number of shares you want to buy and the price at which you wish to buy the stock.
  6. Submit your order.

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Bottom line

Getting into meme stocks can be profitable, but it can also be risky. Do some research to make sure the stock you want to buy is worth it. Never invest more than you’re willing to lose. And watch your position closely; meme stock trends can change rapidly.

To learn more about stock trading, check out our guide.

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