At the start of 2021, the Subreddit known as WallStreetBets became the focus of a media storm as users made thousands of dollars on GameStop stock. This sparked huge media attention surrounding what became known as the meme stock phenomenon. But not everyone understands what this means or does. In this guide, we'll be covering exactly what the trend is and a few other details that you should know about it.
The meme stock trend is a phenomenon where a group of Redditors get together and buy on low-priced stocks. The goal is that enough people will buy them that the price goes up dramatically in a short amount of time. The users then sell their stocks at the new inflated price, which will lower the stock's price and generate huge profits for the users.
Next, we'll outline in exact details just how this process works with GameStop as an example.
How Does Meme Stock Work?
The idea behind this trend is similar to how hedge funds work. That's why, for the most part, it's legal. However, hedge funds and large regulatory bodies such as the SEC don't like WallStreetBets because it isn't a large organization that comes under their rules. Instead, it's a group of people working together to do what hedge funds do without paying extortionate fees for wealth management.
The group of Redditors all meets together on WallStreetBets. There, a group of people with interest in the stock market discuss which stock they should buy and try to make money from. Usually, they look to the stocks that have been shorted. These are generally businesses that hedge funds deem as economically viable. The only reason hedge funds hold stocks in them is for a potential long term benefit.
Most of these companies also have single-digit share prices. This is because they're easier to justify buying for any users on WallStreetBets. However, these shares are also easier to boost with multiple individual investors buying them.
In the case of GameStop, and most other stocks that follow this trend, hundreds of individual investors will start buying up the shorted stock. This creates a ‘squeeze.' It sees the price of the stock dramatically increase. Now, those investors own stock that is worth multiple times what they purchased it for.
Selling at the Right Time
The key to this trend is getting out at the right time. Individual investors can choose to hold onto their stock for as long as possible, but that might mean that they lose out on the largest profit margin.
When the community begins to sell, the stock price will fall. This means that more investors will sell, and the price will drop faster. If everyone agrees to sell at once, everyone gets a bigger profit. For those who don't sell though, the price difference can see them lose money.
Enemies of Hedge Funds
The key to what makes this investment trend work is the collective enemy that they've created for themselves. The stocks they invest in have been heavily shorted, meaning that they're expected to drop in price or take a very long time to rise, if ever. This is how millionaires and billionaires invest their wealth and live off of it. In effect, with a hedge fund managing their money in this way, they can live off of the profits and still pay the fees.
Individual investors are usually much poorer and can't afford to pay a company to invest on their behalf. That's why they enjoy boosting the shorted stock. This actually harms the hedge funds. Since the larger organizations bet on the stocks falling, they lose out on money because they were wrong, and they can't change that in the short-term ‘squeeze.'
The meme stock trend isn't likely to go away any time soon. WallStreetBets has been around for years, and individual investors will likely continue to use it for as long as they can. Everything they do is legal and carries the same risks as a normal investment on the stock market. However, with the backing of a community, you're far more likely to make a profit than you are investing on your own.