- Investors and traders had seen meme stocks for the first time earlier this year.
- Although it seems like a funny situation, it can be an expensive mistake for beginners who have no idea what’s going on.
- New investors might want to consider a safer investing strategy.
The internet is a revolutionary invention that enables people to do things within the comforts of their own homes. And yes, that includes investing and trading the stock market.
Recently, we saw how the internet can affect the stock market with the power of collective users and even memes.
Yes, memes, those funny pictures you see on Twitter and other internet platforms…
What is meme stock trading, and how does it affect stock investments? Let’s find out.
GameStop to GameSTONK | What Happened?
If you’ve been an active internet user in the past months, you might’ve heard about the recent GameStop scenario.
Due to the effect of digital downloading and retail game sales, GameStop stocks had seen a steady decline in their price in the past few years. But from late January to early February this year, its stock price went through the roof.
And the unlikely culprit for this price change was Redditors. WallStreetBets is a channel where stock traders discuss stock and trading in general.
A discussion about short selling started this financial movement, which cost financial institutions billions of dollars.
Typically, short-sellers have quite a bad reputation due to them making money by negative wagers.
They are known for exploiting certain aspects of the stock market for their own gains. And some of the biggest short-sellers are big financial institutions like hedge funds.
And it just happens that GameStop stocks are one of their favorite stocks to sell shorts.
So, the group of Redditors banded together and created the biggest stock price inflation the market had seen in ages. They bought GameStop stocks to drive the stock price.
The Rise of Meme Stock Trading | GameStop Explained
The GameStop meme trading has a lot of things going on than what meets the eye. Typically, investors from the stock market earn profit by positive wagers.
They buy stocks that seem to get an increase in value in the future. Profits are usually gained by buying low and selling high. But this is not the case for short selling.
Short Selling Explained
Short-selling is the process in which you bet for the stock price to go down to make a profit.
Sellers would borrow stocks from brokers and sell them to other investors on market price. Later on, they will have to buy the stocks back and return them to their broker.
If the price goes lower, the short-seller earns a profit, while the reverse happens when the price goes up.
- For example, Robert borrowed a stock valued at $2 on January 1. He needs to return this stock to his broker before January 31.
- On January 3, Robert successfully sold the stock at the market value of $2.
- When January 31 comes, the market price of the stock was lowered down to $1, which he bought and returned to the broker.
- Overall, he received a $1 profit in this trade.
Hedge Fund Dilemna
Hedge funds are some of the biggest short-sellers in the market. They usually borrow the volume of stocks to short-sell, creating profit when it does.
GameStop is usually in their portfolio due to the company’s downward trajectory for the past few years. It is continuous to have a downward trajectory until the meme broke out.
By buying the GameStop stock, the Redditors were successful in driving the prices upwards. In fact, the net change even reached more than 100% on January 27.
Short-sellers don’t own the stocks they sell; they borrow them. And when the time comes to return it, an increase in price means a loss for them.
What Happens After the Short Squeeze?
Three parties are heavily affected by this unexpected turn of events: the big short-sellers, those who gained profit, and those who don’t know what they’re doing.
Hedge funds like Melvin Capital Management who shorted on GameStop heavily, reportedly lost $3 billion at the end of January.
Naturally, those who already had GameStop stocks in their portfolio had managed to gain an incredible amount of profits.
This profit is made by selling their own shares while the demand was high, adhering to the “buy low, sell high” rule of trading.
Unfortunately, new investors who are just riding the meme and bought GameStop at high prices will take losses.
Hence, it’s very important to know what you’re doing when handling stocks and finances. Memes are funny, but they might not be a good influence on your stock investing solutions.
What Qualifies as a Meme Stock?
A Meme Stock is any stock that became popular due to conversations about it online. You can say that these stocks are “viral,” which in turn causes a sudden price spike.
Any changes in their stock price aren’t from the company’s performance. When the hype is gone, the stock price will normalize, and a big crash follows.
When a stock is creating a big buzz, not because of their products or company performance, this is likely a meme stock in the making.
Unfortunately, inexperienced investors are likely to be driven by the hype and buy stocks without knowing the reason behind it.
Should You Invest In Meme Stocks?
Interestingly, buying and selling meme stocks can become a great profit maker if you’re an early adopter.
Investors with previous experiences in stock trading might notice that a stock is undervalued and starts to buy more while the price is low. However, if you’re new to investing, meme stocks are not recommended.
There is an air of mystery when it comes to meme stocks: you don’t really know when such stock would appear.
That’s why the GameStop scenario seems to have blown out of proportion overnight. The possibility of profits is high, but the amount of risks is also material.
How Should a Beginner Trade Stocks?
Each person has a risk appetite: some are comfortable in the idea of losing some if there is a chance of earning more.
But for beginners, the safest approach is recommended: stay in low-risk investments until you’re more comfortable about your skills in the market.
Do Your Homework
Before buying a single stock from a company, you must research its performance and make a proper analysis. Only buy stocks that will work well on your portfolio, and not due to word of mouth or internet hype.
Base Your Decision on a Company’s Performance
Stock prices increase organically when the company is expected to perform great. It’s either due to a new product, new services, or the trend of growth in the future.
Either way, you should base your decisions on things that you can evaluate, and not just on hype.
Start on Low-Risk Investments
Low-risk stocks are stocks that have a low chance of lowering prices in the projected months or years. These stocks will have a lower reward, but it’s also less likely that you’ll lose your money.
Know Some Valuation Metrics
And lastly, learn some valuation metrics to measure up how a company’s finances are doing. The Debt-to-Equity ratio, Price-earnings ratio, and Price-to-sales ratio are great places to start with.
Image by Geralt