Meme Stocks Risky Or Not? Why Investors Need to be Cautious

Last Updated on July 20, 2021

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To understand meme stocks, first you have to understand memes.  And if you’re on social media, you definitely understand those. From the “distracted boyfriend” to The Weeknd looking around, those giggle-inducing captioned images are unavoidable if you’re a serial scroller. So are meme stocks … those? Well, not literally. But they function based on the same concept. And they’ve already made the SEC and the House Financial Services Committed very concerned. 

Meme Stocks Explained 

Just like the Internet images they’re named for, a meme stock is powered by social currency. And, because of that, its value goes up and down based on attention and popularity on social media. And that’s it. That’s right. The value of a meme stock has very little to do with company performance, financials, or even what it’s actually selling. 

Given all this, you might already suspect what the answer is to the question, “Are meme stocks risky to get involved in?” Read on to get more info on meme stocks, and the detailed risks they pose, especially for the novice investor. 

GameStop: The Most Popular Meme Stock

A couple of years ago, if you went into a GameStop, you wouldn’t have thought this was an exciting company to invest in. The financially flailing mall staple is not exactly selling the most cutting-edge tech products. But the video game retailer became the first meme stock to gain fame.

At the beginning of 2021, this meme stock was $19 per share. At the end of the month, it peaked in the high $400s. It came down from there, but not in a straight line, and at the time of writing, it’s trading at $282 a share, over 14x more than at the beginning of the year. 

So how did that happen? If you’ve been living under a rock and didn’t know anything about the meme stock craze, you might think GameStop partnered with Apple to create a new video-game phone that revolutionized the industry. But, no. It all happened in a forum online. Reddit.

The popular social media site, known for its subgroups where people go back and forth on a particular topic, attracted users who started “pumping” the stock, or buying it at breakneck pace and then selling it when the price gets extremely high (then starting it all over again). But why did they do this? Is it because they just love GameStop? No, there’s a more specific reason (or, actually, target): The Redditors took aim at hedge funds, who were “shorting” the stock.

Shorting is betting on the price of a particular stock going down instead of rising, and while risky, it’s generally based on a good deal of critical analysis about the health and future prospects of a company. Hedge funds weren’t thinking GameStop had much life left. It’s also safe to say that, if left unchecked, many everyday investors also wouldn’t look at this brand as the future of retail and a good place to sink your money.

But the Redditors weren’t looking at it that way. They weren’t investing based on the health of the company. They joined in numbers to simply buy the stock en masse, which raised the price — and they actually thwarted the big, powerful hedge funds.

Does that mean the investing game has changed, and that you can join the meme stock crazy without worrying about it being risky? We’ll get to that in a bit.

Other Popular Meme Stocks Explained

GameStop wasn’t the only game in the meme stock craze. AMC, Bed Bath & Beyond (BBBY), and Blackberry (BB) — yes, that handheld device you swore by in 2008 — got caught up in the same situation. AMC was at a low of $1.98 a share in early January 2021, not surprising in the middle of a global pandemic when movie theaters were shuttered. When the stock exchange bell rung on June 2, 2021, it opened at $32.04 (NOT a typo) — a stunning rise of over 1,600 percent from that peak.

But get this: in this trading day alone, the stock closed at $62.55 — a near-doubling of the stock’s price in ONE DAY. Yes, at this point, movie theaters had largely reopened. But this is not an explanation for a stock nearly doubling in one day. Rather, it was the same stock-pumping response as GameStop.

Another meme stock is a cryptocurrency (which, along with meme stocks, is another category that rocked the markets in 2021). The currency, called Dogecoin, was originally created as a joke. It dipped down to a low of $0.0075 per share in January of this year. 

The cryptocurrency Dogecoin, which was initially created as a joke, also saw exorbitant gains, going from as low as $0.0075 per share on Jan. 28. It rose by over 50% on Feb. 4 when Elon Musk tweeted that it’s the “people’s crypto”. A few days later it was at around $0.08 a share, over 1,000 percent or 10 times higher than its low.

On June 2 Dogecoin was trading at over $0.41 a share, or well over 50 times its low. As with the other stocks, it hasn’t been a straight line up. This happened even after a major dip following a Saturday Night Live sketch where guest host Musk admitted that dogecoin is a “hustle.” 

So … Is It Risky to Invest in Meme Stocks?

Meme stocks can be fun to invest in. And it’s possible that you can make money — maybe even a lot. But when it comes to the question of “are meme stocks a risky investment?” the answer is an unequivocal yes. And you have to understand the risks before you play the game. Here are some of the big ones:

You can lose a lot of money. This seems like it goes without saying, yet we have to say it. Keep in mind once again that meme stocks do not move based on facts or research. They just move based on social media popularity. So they can rise and fall at will. Even after making money on meme stocks,  a lot of novice investors often lose it — and more — because they hold it, thinking it’ll keep going up. It’s literally like gambling at a casino. If you don’t quit while you’re ahead (if you even get ahead), the downfall can be swift. 

You can lose perspective. This is an especially important caveat for beginning investors: If you put too much time or energy into meme stocks and you are also trying to make a go of traditional investing, you could easily forget the basics of investing: to buy and hold quality companies with solid management and financials. Many may start to apply the “pump and dump” mentality that defines meme stock trading to traditional investing, which could mean even more losses. Bottom line is that if you’re a beginning investor, overleveraging on meme stocks could seriously skew your concept of what investing really means. 

You can lose faith. Again, this is especially relevant to novice investors. History and precedent have shown that there’s tremendous benefit to starting a responsible, balanced investing plan early on, giving you a long timespan to ride the highs and lows and grow over time.

Final Note on Meme Stocks

Here’s the bottom line: meme stocks are an unpredictable, volatile investment and should be approached with extreme caution. If you do invest in them, make sure that the money you’re devoting isn’t coming out of your savings or being diverted from a responsible, long-term investing plan.

If those bases are covered and you do want to try your hand at meme stocks, keep the amount reasonable and ask yourself, “Will my life change in any negative way if I lose every cent of this?”