If a serious investor was asked “Should I buy meme stocks?” a few months ago, the obvious answer would have been no. When GameStop (NYSE: GME) and AMC (NYSE: AMC) became favored by traders using Reddit’s WallStreetBets, many people were shocked at the sudden phenomenon of investing in struggling companies.
Things have changed slightly since then and there are now actually worthy companies like DraftKings (NASDAQ: DKNG), Lemonade (NYSE: LMND), and Chinese-owned NIO (NYSE: NIO) being caught up in the meme stock craze. This has puzzled many people and encouraged some to consider buying shares in the hopes that they will make a tidy profit when the stock goes through a short-squeeze.
However, this type of investing is very risky and should be avoided by investors that are not able to stomach severe volatility. Here are a few of the reasons why you should be very careful when investing in meme stocks.
1. Extreme volatility
Like we mentioned above, meme stocks are extremely volatile. The nature of these investments is to cause a company’s stock to rise all of a sudden so a short seller, someone who has betted that a share price will fall, will be forced to buy back shares to cover their positions.
Therefore, a meme stock investor makes a profit when the accumulation of other traders buying shares to get in on the jump, plus short-sellers covering their bets, results in a stock soaring. Most of the time, it is not as simple as that though. There’s usually a lot of volatility in between which causes many to panic sell resulting in huge losses.
2. Lack of sound investment thesis
Stock market investing is all about buying stocks that you truly believe have the potential to generate wealth. Most investors understand that investing is not a get-rich-quick scheme and you won’t become a millionaire overnight. Unfortunately, many people buy into meme stocks believing that it will make them rich instantly and don’t bother to look into the fundamentals of the company they are interested in.
Buying shares of a company that has high levels of short interest, which is something meme stock fans look for, is not a good reason to invest. Innovative technology, inspiring leaders, robust revenue streams, and many other factors should be the reasoning behind you purchasing a stock.
MyWallSt discusses the foundations on which you should build your investment philosophy in our 6 Golden Rules. Following these principles will allow you to build a profitable portfolio that won’t keep you up at night worrying about your stocks.
3. Easy to get caught up in the game
Fear of missing out (FOMO) plays a big part in meme stocks. When investors see a company’s share price skyrocket, it’s normal for them to want to get in on the action. Seeing lots of people hype a stock on social media can make it seem like it is a good idea to buy. However, we need to remember most of these people are not financial analysts and they most likely have shares in that company so it’s in their interest for the stock to jump.
It’s very hard to get in on a meme stock at the right time (when the stock is at its lowest price before the potential short-squeeze) and often it comes down to luck. Unfortunately, what happens to a lot of people is that they buy the stock at its peak, or else the squeeze that they were promised by Reddit never comes.
Disclaimer: MyWallSt does not condone short-squeeze trading of meme stocks or any other stocks.
If you prefer to invest in less risky companies with real fundamentals behind them, MyWallSt’s got a shortlist of market-beating stocks so you can generate long-term wealth. Start your free trial now.
MyWallSt operates a full disclosure policy. MyWallSt staff currently holds long positions in companies mentioned above. Read our full disclosure policy here.
Content Writer at MyWallSt
Nicole's favorite stock is Etsy because she loves its original and handmade items. She believes people are going to stop buying mass-produced items and start purchasing ‘one of a kind’ fashions and furnishings. In a world of sameness, Etsy has the advantage.