Investors can't stop talking about meme stocks. And making money trading them has never looked easier — or more fun. But before you really go YOLO with your life savings there are some things to keep in mind.
In January, everyday traders teamed up on the subreddit r/WallStreetBets to send GameStop’s stock price soaring, sticking it to hedge funds who had bet against the video game retailer due to its layoffs and dwindling sales. Then in early June, investors became fascinated with AMC as the movie theater chain — which warned of a potential bankruptcy less than a year ago — saw its stock nearly double in just one day. Shortly after, Blackberry began surging as the Reddit crowd turned their attention to the tech company.
Experts have been warning about the risk associated with buying up meme stocks -- names that attract tons of interest via social media, often temporarily, no matter their actual underlying fundamentals. But if you’re watching people online make a ton of money off these stocks or, similarly, get rich off of risky investments like cryptocurrency, it’s understandable that you might want in.
Here’s what you need to know about picking the next meme stock.
How to find the next meme stock
It’s actually not too difficult to identify potential meme stocks, says Matthew Tuttle, chief executive of Tuttle Capital Management, which recently launched the FOMO ETF, a fund attempting to actually capitalize on the hype around meme stocks while limiting risk. Retail investors — empowered by commission-free online trades through sites like Robinhood and banding together online — look for small-cap companies with a large amount of short interest from institutional investors. (Short sellers are essentially betting against a company by borrowing then selling shares of a stock they think will go down in value.)
The tough part is getting the timing right. “It’d be great to predict it, but I’d rather join the parade than try to start the parade,” Tuttle says.
That’s because for a meme stock to actually take off, it needs the rocket fuel from the Reddit crowd. If you're just investing in a company that Wall Street says would make a good short sell, "you're probably investing money in a company that stinks,” Tuttle says.
Of course, trying to jump on the front of the parade has its risks too. If you buy too late, just before the crowd decides to move on, you can end up losing big as the stock plunges back down towards its pre-meme value.
Are meme stocks scams?
Investors are always told to be on the lookout for pump-and-dump schemes in which fraudsters create a buying frenzy around a stock by spreading false or misleading information, then sell their shares once the price has been jacked up.
Is that what’s happening with meme stocks? Many have taken to Twitter to say yes. And David Trainer, CEO of investment research firm New Constructs says a “pump-and-dump scheme” is a fair way to characterize what’s going on here.
“Pumped, to me, means being pushed to a place where it loses connection to anything rationally related to fundamentals,” Trainer says. “And that’s what we’re seeing here.”
Even if this isn’t necessarily a deliberate fraudulent scheme, there are big drawbacks to jumping on the meme stock bandwagon. If you don’t have any sort of underlying fundamental anchor or connection to a real business model or valuations, you’re taking huge risks, Trainer says. Your investment could go to zero.
“The big risk with the meme stock investing is that it’s all based on the whims of the crowd,” he adds.
Should you invest in meme stocks?
If you still want to try to take advantage of the meme stock frenzy, you can do it responsibly.
First, size these stocks appropriately in your portfolio. The FOMO ETF sizes the stocks it includes based on their volatility: the more volatile a stock is, the lower percentage it’s going to have in the portfolio (GameStop and AMC, for example, are both currently at less than 1%). You can take a similar approach when it comes to putting risky investments like meme stocks, cryptocurrency, options and even individual stocks in general in your investment portfolio. (Money tends to recommend mutual and exchange-traded funds rather than individual stocks). Financial advisors typically recommend only allocating around 2% to 3% — definitely no more than 5% — of your total portfolio to these riskier investments.
While financial advisors also tend to suggest buying and holding stocks, instead of trying to time the market, meme stocks are probably not buy-and-hold stocks, Tuttle says. You’ll want to put in place some kind of exit strategy, like selling some of your investment if the stock becomes too big a percentage of your portfolio.
And, as hard as it is, if you’re going to invest in meme stocks you’re going to need to be able to stomach volatility and be fine with losing out. If you sell some of your holding and the stock price jumps 100% the next day, you don’t want to beat yourself up.
“It might happen and it probably will,” Tuttle says.