It started in August 2020 with GameStop. Then AMC and Blackberry Limited. And now Tupperware, Yellow, and Rite Aid are the latest companies to be turned into meme stocks. While meme stocks can see their prices increase over 1,000% (GameStop) and some meme stock companies have seen their stock prices remain higher over time, the volatility in meme stocks is incredibly high and many of the companies that become meme stocks have seen their stock go even lower after a meme stock rally (or have been delisted like Bed,Bath & Beyond), leaving retail investors with nothing. Ultimately, meme stocks are incredibly risky because they are at the whims of investors’ emotions rather than true predictors of value (i.e., earnings, new product development).
As a Financial Professional (FP), it is important to understand a client’s motivations if they want to pursue a meme stock (or meme stock ETF) and how these align with their plans and goals. Even clients who aren’t interested in investing in meme stocks may use meme stock rallies to predict the stock market’s near- and medium-term performance. This too can be misleading as investor sentiment and market realities can be terribly misaligned. Understanding why meme stock rallies occur and how they can affect the overall market can help FPs guide their clients through market volatility—including upswings that may be unrelated to fundamental economic indicators.
Trying to define or explain a meme can be a surprisingly difficult task. Memes, at their core, are representations of the current zeitgeist—trends, products, people, and ideas can all become memes. Ultimately, there are two key characteristics that underlie memes—they are driven by social media, and they require some level of virality. Meme stocks, specifically, are the combination of memes and the stock market—they are stocks that have become popular (gone viral) because of social media. The companies that gain meme status are usually failing and/or have low stock values. Another important component of meme stocks and something that falls squarely on the investment side of the social media-stock market overlap: the stock usually has a high level of short interest (shares that have been sold short and have not been covered/repurchased). Short interest can increase in a stock because investors expect the price of the stock to decrease—this is how they make money on the (short) sale of shares they have borrowed.
In short selling, the seller only makes money if the stock price is lower than what they originally borrowed shares at and shares must be “returned” to the lender by an agreed upon date. This means that if stock prices increase above what the stock was borrowed at, the short seller loses money (the difference between the higher price and the borrowed price). When there is a large amount of short interest (usually anything above 10% of a company’s shares), there can be a short squeeze—this is when short sellers try to buy shares as quickly as possible to cover their positions and avoid further losses.
Meme stocks are a relatively new phenomenon—the first meme stock was born in August 2020 when Reddit users decided to start rallying behind GameStop. At its peak, GameStop’s short interest was just under 142%1—that means the same shares were being shorted multiple times. This level of short interest can destabilize stock markets in the face of a short squeeze as losses snowball and short sellers panic and cover their positions, which only further increases the stock’s price, exacerbating losses and the associated panic. The short squeeze on GameStop’s stock resulted in the loss of billions of dollars for institutional investors and forced one hedge fund out of business.2
The stock market rally behind the GameStop short squeeze was initiated and encouraged by users on the social media site, Reddit. The push for the rally was emotional—some cited nostalgia for the company while others got involved because they wanted to punish institutional investors. As the price increased, more investors jumped on the bandwagon, driving the price up further. In other words, the sudden and continued increase in prices for GameStop shares was not driven by any news or recent developments around the company, it was driven by emotions.
Meme stocks are fascinating because they should rarely happen. According to the efficient market hypothesis, asset prices reflect all available information—this means that if a stock is expected to rise in value, this is reflected in its price. Another way to think of this is, if a stock is undervalued, investors can purchase it with the plan of making a return when the price goes up—but this very act of purchase drives the price up, bringing the asset to its true value. While there are market anomalies that go against the efficient market hypothesis, these are usually corrected quickly, making it very hard for any retail or institutional investors to consistently beat the market over time.
In 2022, meme investing took a downturn with the rest of the market. The meme ETF3 (ticker: MEME), started in December 2021 by Roundhill Investments, dropped from $70 per share to $25.4 Further, many of the meme stocks that had dramatic price increases in 2021, saw prices drop sharply, with some ending below where they were before meme investors started a rally. Even those that did maintain a higher price level did so at prices significantly lower than what they peaked at. Many analysts thought that meme stocks had run their course and were a trend unlikely to be continued. And that did seem to be the case through 2022, but recently there has been a resurgence. The meme ETF has gone back up and even outperformed the S&P 500.5 And a new crop of fan-favorite stocks has appeared, including Tupperware,Yellow, and Rite Aid.6 Shares for these companies have risen as much as 800% in the past few weeks, despite all three of them having given indications of failing.7
This resurgence has led some analysts and hedge fund managers to declare the landscape of the stock market permanently altered8—suggesting that short-selling has become even more risky as retail investors can cause billions of dollars in losses just because. This means that analysis and research can suggest a reasonable course of action, such as short selling because of an expectation share price will decrease (e.g., Yellow signaled it planned to declare bankruptcy), and that action can result in major losses because of chatter on social media platforms. Even just the threat that meme investing could resurge after a lull adds a dimension of risk that will make many institutional investors uncomfortable with short-selling specific stocks.
Price Changes Feb 2022 – Aug 2023 for: MEME (dark blue)and the S&P 500 (light blue).
Source: Yahoo! Finance
As an FP, you may be faced with clients who would like to invest in meme stocks, engage in short selling, or who make decisions based on investor sentiment. For these reasons, it is important to understand why meme investing occurs and how best to respond to the emotions and blind spots driving interest in meme stocks.
The most prominent drivers of meme investing are social in nature: social networks, herding, the fear of missing out (FoMO), and a need to belong. All meme stocks are started online, usually through the subreddit r/WallStreetBets or other social media platforms. This is how meme stocks spread and become increasingly popular. This virality is also a form of herding. Specifically, people start investing in a meme stock solely because others are. Underlying this is, more broadly, social influence. Everyone is influenced by social dynamics such as norms and culture. When social media posts about a stock amplify, some people will use this information as social proof—inferring the stock is a good investment because others say it is (rather than conducting a thorough analysis and comparing that analysis to their plans and goals).
Another motivator can be FoMO. This is distinct from social proof as it is about being left out or feeling regret. Individuals can feel different levels of FoMO—research has found that younger males are most prone to such feelings9—but ultimately, FoMO can increase the likelihood of herding. Given that meme stocks are highly volatile, a careful risk analysis would find that many investors’ risk tolerance does not support investing in such stocks. This means that individuals are investing in meme stocks almost entirely because of social influence and/or FoMO. Therefore, the meme ETF exists solely to cater to investor emotions. Given this is a true market anomaly and the result of investor irrationalities, it can be capitalized on—by retail investors and day traders—but the risk of betting against the herd is still quite high.
As an FP, it is important to temper investor emotions. For clients who are prone to herding and FoMO, suggest they avoid using social media for financial research of any kind. If they insist on participating in meme investing, have them do so with only very small stakes. Hopefully, this lower-risk form of market participation can satisfy their desires to jump on the bandwagon. You can also remind them that herding can result in huge price jumps, but to really capitalize on meme stocks, they must be able to time the market. This requires vigilance and is quite difficult to do—ultimately reducing investing to a form of gambling and the pursuit of a big payout that is unlikely to come en masse.
It is important to keep in mind that the desire to invest in meme stock is not the result of changes in risk tolerance, but rather a change in the perceived risk. This means that clients are not well-calibrated to the objective risk and, rather, are driven by the potential upside alone (or they see the potential downside as much less than it is). This change in subjective beliefs is driven by the social dynamics discussed above.
To address this misalignment in risk assessment and true risk, FPs can focus clients on the losses involved—showing them the worst-case scenario. The issue is that many investors who experience FoMO are focused on the positive price changes (the huge upswings) rather than the overall volatility or the swing back down. Reframing the risk in terms of downside and volatility can help to attenuate some of the excitement about meme stocks. For example, during the GameStop rally, approximately $30 billion of on-paper wealth was completely wiped out.10 It may also be important to note that even if they make money, it likely will not be as much as if they had timed the market better—this can induce regret aversion. Oftentimes emotional reasons for investing can be overwhelming, and the best way to combat emotions is with other emotions (e.g., loss aversion, regret aversion).
Speaking of loss aversion, it can play an interesting role for individuals already invested in meme stocks. Specifically, some investors may hold their meme stocks too long. There is even a term for these individuals in the meme investing world: diamond hands. These are investors who hold the meme stock, even in the face of heavy losses, because they strongly believe the price will increase. To understand how this relates to loss aversion, you must understand an important, often overshadowed, component of prospect theory—diminishing sensitivity. This means that as losses get larger, the pain of each additional loss lessens. For example, moving from $0 to -$100 hurts a lot more psychologically than moving from -$9,700 to -$9,800. This is an important implication of prospect theory because it means that people will become increasingly risk-seeking over large losses. There is also a strong desire to come out even (return to the status quo or net zero). This also increases risk-seeking over losses as people take on more risk to breakeven.This explains things like increased long-shot betting towards the end of the day11 and greater afternoon risk-taking by day-traders after morning losses.12
Source: Coval & Shumway, 2005. This chart shows the afternoon total dollar risk conditional on morning profit percentile for 236 day traders. This shows that day traders in the lower morning profit percentile take above-average risk in the afternoon in an attempt to breakeven.
To avoid diminishing sensitivity to losses, it can be helpful to separate out the losses as they occur. For example, frame losses as daily price changes—this way each move from $0 to -$X hurts more than when all the losses are summed together. While this strategy is not a good idea for long-term investing and should be applied very selectively, it can be helpful in getting clients to cut their losses when they should.
Investor sentiment and economic reality do not always coincide. Meme stocks demonstrate how investors’ emotions can drive both specific stock prices and the entire market. As an FP, it is important to understand the underlying drivers of meme investing and how best to address blind spots clients may have in this arena.
Meme investing is driven by emotional forces: social proof, herding, FoMO. To help clients avoid emotional investing:
Invested clients may hold meme stocks in the face of heavy losses. To help attenuate their diminishing sensitivity to loss aversion, separate out losses as they occur (every time the price dips below the purchase price).
Atlas Point can help you identify which of your clients are most prone to these blind spots and emotional responses. You can assess clients for several biases, including herding, overconfidence (which also contributes to irrational expectations for meme stocks), loss aversion, and regret aversion, via our signature Financial VirtuesTM survey. You can try our Financial VirtuesTM survey here:
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Meme stocks like GameStop and AMC captured the market's attention in 2021. Now meme stocks are having a resurgence and they have changed the landscape of investing as a result. Understanding meme stocks, their risks, and their impact on the entire market is crucial.
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[1] McCrank, John. “Explainer: How Were More than 100% of GameStop’s Shares Shorted?” Reuters, 18 Feb 2021, https://www.reuters.com/article/us-retail-trading-shortselling-explainer/explainer-how-were-more-than-100-of-gamestops-shares-shorted-idUSKBN2AI2DD.
[2] Reimann, Nicholas. “GameStop Shares Skyrocket 50% In Extended Trading After Reporting Surprise Profit.” Forbes, 21 Mar 2023, https://www.forbes.com/sites/nicholasreimann/2023/03/21/gamestop-shares-skyrocket-50-in-extended-trading-after-reporting-surprise-profit/?sh=6d2c9169f3bb.
[3] Another meme stock ETF is the VanEck Social Sentiment ETF (ticker: BUZZ). From VanEck’s website, this fund “track[s] the performance of the 75 large cap U.S. stocks which exhibit the highest degree of positive investor sentiment and bullish perception based on content aggregated from online sources including social media, news articles, blog posts and other alternative datasets.” See here: https://www.vaneck.com/us/en/investments/social-sentiment-etf-buzz/overview/
[4] “Meme Stocks Are Back from the Dead.” The Economist, 10 Aug 2023, https://www.economist.com/finance-and-economics/2023/08/10/meme-stocks-are-back-from-the-dead.
Roundhill Investments introduced the meme stock ETF, MEME, in December 2021. The ETF is a portfolio of 25 stocks, where securities are included based on a “meme score.” This score is calculated as the number of times a firm is mentioned on pre-specified social media sites over a 14-day period and with additional weight given to a company’s short interest. The portfolio is rebalanced twice a month. For more information, see: https://www.roundhillinvestments.com/etf/meme/
[5] “Meme Stocks Are Back from the Dead.” The Economist, 10 Aug 2023, https://www.economist.com/finance-and-economics/2023/08/10/meme-stocks-are-back-from-the-dead.
[6] Miao, Hannah, and Gunjan Banerji. “There’s Something About Meme Stocks: Day Traders Pile In to Tupperware, Yellow and RiteAid.” The Wall Street Journal, 5 Aug 2023, https://www.wsj.com/articles/tupperware-yellow-rite-aid-meme-stocks-soar-c31cf56f.
[7] Lipschultz, Bailey. “Hedge Fund Billionaire Dan Loeb Laments the Victory of Meme stocks.” Fortune, 6 Aug 2023, https://fortune.com/2023/08/06/hedge-fund-billionaire-dan-loeb-meme-stocks-short-selling-trading/.
[8] See [7].
[9] Przybylski, A. K., Murayama, K., DeHaan, C. R., & Gladwell, V. (2013).“Motivational, emotional, and behavioral correlates of fear of missing out.” Computers in Human Behavior, 29(1), pp. 1814-1848.
[10] Phillips, Matt, et al. “The Hopes That Rose and Fell With GameStop.” The New York Times, 7 Feb 2021, https://www.nytimes.com/2021/02/07/business/gamestop-stock-losses.html.
[11] Thaler, Richard H., and Eric J. Johnson (1990). "Gambling with the house money and trying to break even: The effects of prior outcomes on risky choice." Management Science 36(6), pp. 643-660.
[12] Coval, Joshua D., and Tyler Shumway. “Do Behavioral Biases Affect Prices?” The Journal of Finance, 60(1), Feb 2005, pp. 1–34.