Financial Literacy for Kids: A Background on Meme Stocks

Updated March 24, 2023

An Overview On Meme Stocks

It wasn’t so long ago that value investing was the name of the game (👋 Warren Buffet!), but these days memes the word.  But what are meme stocks and where did they come from?  A meme is an internet image, video or text, typically associated with a cultural moment, that goes viral.  Like memes, meme stocks see a surge in internet popularity when they go viral amongst amateur investors on social media platforms. 

So how does a particular stock become memified?  A meme stock is often a beleaguered company with a somewhat bleak outlook, whose stock price begins to fall when investors liquidate their positions. When said company slumps, many Wall Street traders short the stock, or hope to profit off the assumption that the company’s stock will continue to decline. 

the moment of stock memification…

This is the moment the stock can become a meme stock. Amateur investors messaging on Reddit decide either that the company is undervalued, OR that it would be funny to collectively drive the stock back up, effectively punishing the hedge fund short sellers.  Either way, when these retail investors unite en masse to start buying the heck out of the newly-minted meme stock, the price skyrockets and the institutional investors take a major hit closing out their short positions.

Unlike the Reddit investors, these institutional investors typically assess a company based on its fundamentals, rather than its social media popularity.  The more traditional investors insist that the sharp rise in stock price is not based on any fundamental value, the more the Reddit investors revel in driving up the stock price even higher.  It’s a bit like sticking it to the man. 

Why Meme Stocks Are Important

So when did meme stocks become a thing?  As it turns out, not so long ago.  As recently as January 2021, a few factors collided to brew a meme stock market.  For one, Robinhood came onto the scene as an investing platform that allows regular people to trade stocks at little to no charge. Then, millions of new investors, flush with stimulus checks and with newfound time on their hands during the Covid-19 lockdowns, jumped into the stock market.  In late January, small investors on Robinhood drove up the price of GameStop (a struggling video game retailer) far beyond its presumed value.  Since many Wall Street hedge funds had shorted GameStop, when the price skyrocketed, the big institutions lost billions of dollars ($23.6 billion, to be exact).  The GameStop saga emerged from tensions between everyday investors, who feel they are disproportionately left behind on lucrative financial opportunities like IPOs, and big institutional investors like Wall Street hedge funds. 

But the verdict is still out on whether all meme stock momentum is bad.  On the one hand, meme stocks can trade without any concern for the fundamental value of a company, which can lead to unnecessary market volatility.  On the other hand, some of the meme stocks, newly flush with cash after an unexpected surge in stock price, have begun to turn around their flagging businesses and pivot to profitability.  Hertz, AMC and Bed Bath & Beyond became just a few other meme stocks making serious moves.

The Takeaway

Just like in gambling, we believe investors both young and old should not invest in meme stocks with money they can’t afford to lose.  We recommend allocating no more than 5% of an investment portfolio into meme stocks.  Most importantly, kids should understand that “finfluencers” are not investment experts and many social media stars haven’t even been through an actual economic cycle.  In short, trade in meme stocks with caution. 

Extra Credit:  To learn more about momentum trading v. technical trading you can read here.

Do you have an online trading account? Would you ever invest in a meme stock?  Why or why not?