With the onset of the year 2021, the meme stocks have, yet again, been witnessed creating hysteria among the investors. The sharp rise and dramatic falls were seen creating headlines for a considerable amount of time. However, courtesy of the dynamic range of pre-existing and rapidly launching stocks in today’s era, the impact of meme stocks on the overall market is rather minute.
Before going ahead with the issue, it’s necessary to know what meme stock or meme asset really is- A meme stock is one that has gone viral or is insanely amplified over social media, the reason being not the company’s performance but the hype created on social media platforms like Reddit. The unreasonable hype of meme stock trading has led to these stocks becoming overvalued and simultaneously escalates their prices in the broad market
Misty Lynch, financial advisor and certified financial planner with Beck Bode once said in one of the emails to The Balance, “It is really a category for stock that has seen rapid growth and attention on social media channels like Reddit and Twitter. The valuation may not line up with the price changes—or the hype.”Source: www.thebalance.com
Blackberry, a stock that had been far behind in the line for several years now, observed a spike three times its original numbers around 25 January 2021. To add to this amazement, AMC rose by about ten folds. However, the star performer amid all these meme stocks was the GameStop, the virality of which increased its value by hundreds of dollars in a matter of few days.
Since the stupefying sky-high value of these assets is not a result of how the company performed but an insane work of word of mouth all across the social media platforms like Reddit, the nature of these spikes is rather fluctuating – so much so that, after a point, there ceases to exist a reasonable linking between the groundwork of the company and the estimation of its stocks in the market.
Two of the leading causes as to why meme asset mania has been the talk of the town lately are :
- Commission-free trading,
- The Simplicity of the apps, which pulls a lot of beginners and amateur investors and evidently is a source of entertainment to this chunk as they go about experimenting and exploring stocks like AMC and GameStop (GME).
Let’s have a look at how the meme stock cycle works, as explained by one of the users on a Reddit forum. He presented the cycle in 4 stages:
When some investors feel that the value of a particular stock is underestimated, they begin purchasing it in large quantities, resulting in the slow rise of its index value in the broad market.
Due to the sudden rise in the price, people start taking notice of these stocks and start buying them thereby causing the price to further shoot up.
The news about the rising prices of these stocks gains momentum and rapidly spreads all over social media. Seeing this, the remaining retail investors, who are subliminally influenced by their environment – end up buying the stocks.
As this process prolongs, the initial investors start running short on money and therefore start selling creating a domino effect of this action among other investors as well, just like one in the first stage.
Largely, it’s just the first few investors that actually make profits off of this process. Anybody entering after the second stage may not gain much from the same. Being aware of the various risk management in the stock market, you will know how and when to invest.
As attractive as it is to get on board on meme stock trading with everybody else in something that is so appealing and promises huge returns, it also raises some serious concerns for the people in this business. As they say, opportunity and risk come in pairs. In this case, as ginormous as the potential of returns is, so is the size of the risk that may or may not tag along with it which can be avoided by considering investment risk management.
“The chart below shows the one-year price return and risk, as measured by the standard deviation as of 6/11/2021, for AMC and GME alongside the returns for the broad market of S&P 500 and the small-cap index Russell 2000. Both AMC and GME are part of the small-cap universe in the Russell 2000 index.”
|Large Cap Stocks: S&P 500||43.6||16.0|
|Small-Cap Stocks: Russell 2000||74.1||23.8|
As it can be seen from the table, the large and small-cap stocks have shown some commendable returns over the last year with considerable and reasonable risk. However, a world of difference can be observed in the risk and returns from the meme assets. One must always be aware of the risks and returns associated with buying these stocks with the help of meme asset risk management.
To quantifiably analyze the impact of meme stocks in the market, it is important to know the diversity of stocks in the index. For example; the top 15 stocks of A make up 5% of the entire index and the top 15 stocks of B make for 35% of the index. The large variegation in the index indicates that to bring a noticeable change in numbers, be it from the gains or falls, the involvement of a much larger chunk of stocks is almost mandatory.
Now, talking practically, meme stocks like AMC and GME belong to the Russell 2000 index which has a broader multiplicity compared to that of S&P. Hence, overvalued returns or even drastic drops would not affect the overall market.
All in all, it is (ironically enough) safe to say that there is an inevitable risk in the meme assets. Moreover, financial experts recommend going after long-term growth instead of short-term gains. There will surely be people who would benefit from this “casino” but it is always better to play your odds calculatingly and practice a more diversified approach to investing at all times. Nonetheless, a few hits in these assets here and there would hardly, (sometimes, not at all) have an impact on the whole market.
Blog Posted By: Prerna Arora, Student Risk Committee Member