Memestocks: Their essential character explained
In the world of finance, a new trading phenomenon has emerged, known as meme stocks. One of the earliest examples of this trend can be traced back to a German equivalent of Wallstreetbets called "Mauerstrassenwetten," which was founded on Reddit.
The cycle of meme stocks typically begins with a rapid rise in price, driven by retail investors' speculative buying, fueled by social media hype. This is followed by volatile price swings, often leading to a sharp decline once enthusiasm fades or fundamental weaknesses become apparent. Meme stocks do not generally move based on underlying business fundamentals but on collective retail sentiment and momentum trading, often leading to short-lived price spikes.
This cycle includes several stages: initial social media-driven hype attracting a large number of retail investors chasing quick gains; a surge in bullish options trading and call-to-put ratio spikes, increasing speculative leverage; price volatility caused by a herd mentality, short squeezes, and momentum trading; eventually, the trend reverses as valuations become unsustainable, forcing many late investors to take losses. The cycle repeats with new "meme" stocks emerging to capture the next wave of speculative interest.
The impact on small investors is significant. Many enter late due to Fear of Missing Out (FOMO) and may buy at elevated prices near the peak of the hype. These investors face high risks and potential for substantial financial losses as meme stocks are fundamentally weak companies with poor financials like high debt and negative cash flows. Behavioral biases such as herd mentality and recency bias amplify risk and can lead to emotional, rather than rational, investment decisions. The highly volatile nature of these stocks means small investors are exposed to sudden drops, often exacerbated by liquidity issues and the exit of larger, more sophisticated traders.
Experts advise small investors to prioritize fundamentals over sentiment and practice disciplined risk management to avoid the speculative traps typical of meme stock cycles.
A prime example of a meme-stock is the Gamestop stock. It initially stagnated before gaining over 2000 percent in a matter of days due to repeated buy recommendations from users of the private investor forum Wallstreetbets on the Reddit platform. The retail investor community celebrated this as a supposed victory against "Big Finance." However, the bet on the Gamestop stock was highly speculative, and the stock itself offered no fundamental grounds for recovery.
European trading restrictions make it more difficult for small investors to band together and fight against short sellers. In Europe, the share of retail investors accounts for about 5% of trading volume, compared to more than 30% in the US.
Dmitry Ivanov, CEO of the German branch of brokerage firm Freedom Finance, states that meme-stocks are stocks that have gone viral on the internet and caught the attention of investors. The value of seemingly hopeless stocks that make wild price movements on command can implode at any time, posing a danger to small investors.
The cycle of meme-stocks, such as Gamestop, can also run in the opposite direction, leading to losses for investors who joined later. Consequently, many speculators were left disappointed, and the Gamestop stock remains highly volatile to this day.
It is essential for investors, especially small ones, to approach meme stocks with caution. The allure of quick profits can be tempting, but the risks are significant, and the cycle of meme stocks can lead to substantial financial losses. Investors are advised to prioritise fundamental analysis and disciplined risk management over the hype and momentum generated by social media.
- Other social-media platforms, like those in Europe, may encounter a surge in meme stock trading due to the collectivity of investors, given the impact observed on Reddit with Wallstreetbets and Mauerstrassenwetten.
- In addition to traditional finance, the technology sector could witness increased investing activity as meme stocks gain traction, given that online trading platforms enable easy access to these speculative assets.
- Entertainment industries might benefit from increased interest, as meme stocks often create a fervor around enticing investment opportunities, resembling the hype around a popular movie or video game release.
