Should I invest in meme stocks?

Academic Discipline: Financial Economics
Assignment Subject: Should I invest in meme stocks?
Academic Level: Undergraduate-4th Year
Referencing Style: APA
Word Count: 1,031

Should I Invest in Meme Stocks?

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Introduction
Modern social media platforms such as Reddit, StockTwits, Twitter, Discord, and Patreon have changed the way people invest their hard-earned money. These social media platforms have reshaped the trading strategy of small-time retail investors. In the past couple of years, so-called meme stocks have gained immense popularity. Meme stocks are defined as stocks that have witnessed a massive surge in popularity because of social media discussions and significantly higher retail investor trading. Meme stocks often have overpriced share prices as compared to the underlying business (Choy et al.).

Herd Mentality
The short squeeze of GameStop played a pivotal role in reinforcing the belief of young speculators in meme stocks. Moreover, the skyrocketing of AMC stock price just a few months after the GameStop short squeeze clearly indicated that meme stocks are here to stay. Aloosh et al. studied the investment behavior of social media investors and found that many people suffer from the “herd mentality”. Meme stocks often attract novice investors who like to trade volatile stocks that they believe would provide them with asymmetric returns. Ironically, meme stock investors also have a tendency of justifying their investment decisions by posting aggressive messages on social media platforms and calling themselves ‘diamond hands’. Such investment behavior displayed by inexperienced traders points towards irrationality.

Stock markets are the cornerstone of financial transparency and economic stability. Equity indices such as the S&P500 are typically considered to be the harbinger of economic health. However, the complexity of global financial markets sometimes causes erratic and unpredictable investment behavior (Choy et al.). To add to the complexity, high-frequency stock trading can cause irrational market movements and massive intraday price action. In an irrational trading environment, investor impatience is a common phenomenon. Novice investors are quick to sell during a stock market crash as they try to avoid unsustainable financial losses. At the same time, social media investors rush to buy stocks during a frenzy because they expect to make quick profits from a prolonged rally.

Impact of social media on Financial Markets
The short squeeze of GameStop stock in January 2021 was orchestrated on the Reddit website and mobile app. The stock witnessed a massive increase in price of 1,500% in a short duration of two weeks. Subsequently, the stock price crashed the next day as its price dropped by 44% (Choy et al.). Other meme stocks such as BlackBerry, AMC, Bed Bath & Beyond, Nokia and Kodak also witnessed similar price behavior. The short squeeze of GameStop stock highlights the impact of social media on the equity market. Social media platforms such as Reddit’s popular group known as WallStreetBets have made it possible for retail traders to get together, coordinate their actions, and move the financial markets. Additionally, modern-day brokerage firms such as Robinhood and Wealthsimple now enable zero-commission trading for retail investors. This means that the common man can easily trade stocks and exchange-traded funds (ETFs) and engage in the stock market. It has been reported that on peak volume days, retail investors account for almost 25% of the market activity (Choy et al.).

Behavioral Finance
Human beings are emotional creatures, and emotions play a critical role in influencing their decisions. Conventional academic theories related to finance and investing assume that man is a rational investor. However, behavioral finance is based on prospect theory, which replicates the behavior of investors when they face asymmetric gains and a lot of risks. The field of behavioral finance analyzes and studies the behavior of investors and how it affects stock markets. The rise of meme stocks necessitates the need for a new concept called “social finance”, which analyzes how social media, social beliefs, and norms affect the behavior of retail investors (Jung and Jeong).

The Rise of Meme Investing
Memes have taken over the internet in the past couple of years. Almost all social media platforms have several groups and pages dedicated to memes. These memes are generally funny and humorous. Serious issues pertaining to the modern world are often conveyed in a jovial and sarcastic way through memes (Jung and Jeong). In fact, one can say that the younger generations these days communicate with each other through memes. Thus, the momentum of meme stocks is not a fad that will fade away soon. It is here to stay, and it will completely transform the way young people invest in the stock markets.

Costola et al. believe that the GameStop short squeeze strategy caused huge financial losses for hedge funds who had taken short positions because of the company’s worsening fundamentals. Contrary to popular perception, retail investors who orchestrated the GameStop short squeeze were not just active on Reddit. The investor activity was multi-platform, which means that one could see buying signals everywhere on the internet. Thus, the rise of meme investing is not just limited to one specific social media platform. Its reach far exceeds the subreddit r/wallstreetbets. It is clear that such multi-platform stock buying signals have a significant effect on a stock’s trading volume and price (Costola et al.).

Meme stocks are not favored by professional stock traders of Wall Street. However, this does not mean that meme stocks are bad trades or poor investments. As long as investors have a solid rationale behind their decisions, they can think of investing in meme stocks. For example, maybe an investor is buying AMC stock because he believes that audiences will come back to watch movies in the theatre once COVID-19 dissipates. Also, investors should limit their exposure to meme stocks. This means that because meme stocks are risky investments, they should only form 5-10% of an investor’s portfolio (Hartill). One should never invest all their money into speculative assets like meme stocks and cryptocurrencies.

Conclusion
If an investor has some extra cash that he can afford to lose, there’s nothing wrong with jumping in on the bandwagon and investing in meme stocks. However, as the saying goes, “excess of everything is bad”. Meme stocks are highly risky assets because of which there is the potential for a heavy financial loss. No one should put all his savings in a meme stock in the hope of earning a fortune overnight.

References
Aloosh, Arash, Hyung-Eun Choia and Samuel Ouzan. “Meme Stcoks and Herd Behavior.” 23 August 2021. 3 May 2022.

Choy, Jeffrey, et al. “Investor impatience and financial markets: the case of the short squeeze of meme stocks.” n.d. 3 May 2022.

Costola, Michele, Matteo Iacopini and Carlo R.M.A. Santagiustina. “On the “mementum” of meme stocks.” Economic Letters (2021).

Hartill, Robin. 5 ways to invest in meme stocks more safely. 18 October 2021. 7 May 2022.

Jung, Sang Hoon and Yong Jin Jeong. “Examining stock markets and societal mood using internet memes.” Journal of Behavioral and Experimental Finance (2021): 1-16.

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