The stock market is a wild place. In the short term, anything can happen. A prime example of this is meme-stocks. Meme stocks are stocks that are popularized among retail, or individual, investors through social media. The popularity of these stocks, as the name suggests, often comes from memes. Those who invest in these stocks are usually inexperienced retail investors, and they do so as a result of hype and not company performance. The most prominent platform where these memes are exchanged is Reddit.
In January 2021, the stock of a retail chain selling video game-related products called GameStop (GME) rose by over 1000%, not because of good performance; on the contrary, they were expected by most professionals to be a dying company. To capitalize on GameStop’s expected decline, these professionals called hedge funds would borrow the stock to sell in hopes of repurchasing it and returning it at a later date. This is called shorting a stock and every GameStop share was at least shorted once. Individual investors saw this and planned a short-squeeze, where they would buy a lot of the stock and not sell any of it. Because these hedge funds had to return the stock they borrowed back to their lenders; they were forced to buy at inflated prices. As long as people didn’t sell, the price would continue to go up as hedge funds fought with each other to buy the stock while they could still afford it.
Another popular meme stock was the movie theater chain AMC Entertainment (AMC). At the beginning of 2021, its share price was just $2.12, but at its peak on June 18th, 2021, it reached nearly $60, a rise of over 2500%! During the pandemic, many movie theaters had to be shut down including AMC’s. Without its theaters, AMC was doing very badly and became heavily shorted. This made it a perfect subject of a short-squeeze.
Despite the seemingly huge gains, this strategy is far from risk-free. The underlying companies for these meme stocks often suffer from weak performance and are overvalued. In the short term, the stock market is a supply and demand graph, but in the long term, it measures company performance. As companies suffer from weak performances, the stock price eventually catches on and crashes down. As fast as these stocks rise, they also fall. From its peak at $55 a share in August, Robinhood has fallen by nearly 80%. AMC has also dropped by 70% since its peak. And from a price of $300 a share, GameStop is now barely $100.