The meme stock frenzy that started in January 2021 left a lot of institutional and retail investors confused, frightened, and excited at the same time. A mix of emotions that has hardly been experienced before in financial markets. The reason behind it was Gamestop (NYSE: GME).
This brick-and-mortar video game retail chain was one of the most shorted stocks throughout 2018, 2019, and 2020. The company had been struggling to turn profits for a few years. Therefore, many financial institutions and retail investors were betting on the perceived bankruptcy of this once great business. That was until a few retail investors combined their capital in order to pull out one of the largest short squeezes ever seen.
The meme stock is born
Reddit was the gathering of choice for all of the retail investors sharing their speculative bets on Gamestop. Suddenly other stocks were also targeted, and although Gamestop was the most well known, stocks such as AMC, BlackBerry, Nokia, Bed Bath & Beyond, and more were also considered meme stocks. With extreme volatility and abrupt movements in meme stock prices, the financial markets were on the edge. Financial regulators were also on high alert, and the world soon discovered the power of meme stocks.
In January 2021, the short interest on Gamestop was at an astounding 141% of the float. Although this sounds impossible to some investors, it is fairly easy to understand. When a short-seller borrows shares and sells them, a number of shares are added to the outstanding share count. When he covers the position by buying back the shares, these no longer exist. There was certainly a lot of risk-taking by several hedge funds shorting the stock. This is a reminder that although a stock can be a great short, short interest is important to consider, especially when it is that high.
The mother of all short squeezes: GameStop
This movement quickly gained viral traction and resulted in GameStop’s stock price climbing from $20 on 12 January 2021 to $347 on 27 January 2021. That’s a growth of 1,635%, in just two weeks. To put this in perspective, if you bought $1,000 of GameStop on 12 January 2021, you would have $17,350 two weeks later.
There was more to meme stocks than profit
What is particularly interesting about meme stocks is the fact that several investors wanted more than to make a profit. The meme stock frenzy was a statement to the world, governments, and large Wall Street financial institutions. Gamestop investors were more than just looking for profits, they were driven by a narrative that has started with the Occupy Wall Street movement. Stick-it-to-the-man was the motto that drove these frenetic stock price movements in meme stocks.
Investors behind Gamestop
Wallstreetbets: Reddit meme stock community
One of the most prolific investors in Gamestop was Roaring Kitty. An unknown investor, Keith Gill, went by the username, Roaring Kitty. He had started sharing his highly speculative Gamestop options trades on Reddit’s page Wallstreetbets. Many Reddit users started to follow similar trades. Although the media and other news outlets attribute the Gamestop mania to Roaring Kitty, the reality is that the convergence of millions of individual investors in a platform like Reddit created a scenario where this was possible.
The meme stock frenzy had more than just retail investors
Gamestop short squeeze also attracted other participants. Dr. Michael Burry is a well-known investor that achieved a lot of popularity after accurately predicting the housing bubble that eventually led to the financial crisis. He was also involved in the Gamestop saga, after taking a considerable position in the company. This has led him to book some hefty profits, but it has also led the Securities and Exchange Commission (SEC) to subpoena Dr. Michael Burry over Gamestop.
A new documentary explains what happened with Gamestop and meme stocks
A new documentary released by Vice, titled “The Big Squeeze” describes in detail what happened during those months. However, to this day many seasoned investors still believe there were several funds targeting the stock, and trying to profit from the upward movement. This is partially true. It seems highly challenging for a group of retail investors to be able to orchestrate the mother of all short squeezes. There were certainly some large asset managers behind the crazy upward movements in Gamestop, although currently, it is still unconfirmed who was behind these trades.
Several hedge funds took far too many risks shorting an overly shorted stock like Gamestop. Melvin Capital was by far the most prolific hedge fund that ended up with large losses due to the meme stock mania. On the other hand, several retail investors were also taking far too many risks. This ended up with a few big winners and several losers.
A number of retail investors were persuaded to invest their life savings into meme stocks. Well sure some of those bets paid out, but the majority of these investors saw large losses due to the speculative nature of their trades.
Robinhood and brokers
In the midst of this increased volatility in financial markets, brokers were terrified. As more and more investors started making speculative bets, using options some brokers put an end to this. Brokers started to raise margin requirements, before ultimately restricting trading on some meme stocks. RobinHood was the first to take action, restricting trading in some of the most popular meme stocks. This meant that investors could only sell shares and not buy anymore. Interactive Brokers soon followed suit.
Although many retail investors were infuriated by this decision, with many claiming RobinHood and other brokers were trying to minimize the losses of hedge funds, in reality, it is different. When a broker executes an order for an investor they have to put up collateral. As soon as the volume increased significantly on some of these names, the collateral requirements increased. This could pose a threat to the stability of some of these brokers and the whole financial system. Overall markets were not prepared for what they were witnessing.
Trade volume determines the speed of price changes
A stock price goes up when there are more traders interested in buying a stock. Conversely, a stock price decreases when traders rush in to sell their stock. The average daily volume of trades per day on the NYSE is about 995 million shares. One can quite easily understand that with such an active market, stock prices can change quite quickly in a short time frame.
So with retail investors, and large unknown market players repeatedly buying a specific stock in a short time frame, the price kept going up. GameStop, AMC, Blackberry, and others have been targeted by online communities like Reddit as stocks to buy and HODL (hold on for dear life). With the main intention of getting back at large hedge funds and institutional investors that profit on the fall of low-performing or declining stocks.
The meme stock runner up
AMC is another example of a meme stock. The stock was trading below $3 per share during January of 2021. Following the Gamestop meme stock saga, the stock soon got traction and had an all-time high of $62.55 on the 2nd of June 2021. Once again showing the impact of social media and online communities to impact the market and drive a share price up.
$1000 invested in AMC on the 19th of May 2021 would’ve turned into $4,950 by the 2nd of June 2021. Although the two-week climb is not as impressive as GameStop, a return of nearly 500% on your investment in two weeks is still very impressive.
The influence of herd behavior
There are several different opinions on what drove the meme stock mania, with Gamestop as its poster child. We cannot dismiss the impact of certain psychological phenomenons that intensely drive human behavior, namely - Herd behavior. Even though the climb of the share price of GameStop was sparked by an online community on Reddit. The mass and continuous impact is not a result of that community alone. As the stock price went up, people all around the globe saw one thing: Other people are buying GameStop.
Herd behavior dictates that people follow other people’s decisions in times of uncertainty. So when a stock price suddenly increases buyers step up looking to buy even more. As millions jumped into the buy-train, Gamestop’s price soared day after day. Not due to their understanding and research of the stock, rather based on the assumption that other people would keep buying.
This blind reliance on other people’s decisions is what is known as ‘herd behavior’ and is increasingly evident in an always-online world. News travels fast in the internet age, and when a quick money-making opportunity presents itself, more people follow suit. This continued to fuel the increasing share price.
Meme stocks are leaving their mark on Wall Street. Impacting financial markets all around the globe. Overthrowing institutional investors’ short positions, one stock at a time. It started with GameStop but has subsequently transferred to AMC, BlackBerry, Nokia, Bed Bath & Beyond, and more.
However, the disconnect between price, and fundamental value of certain stocks is nothing more than highly speculative behavior. The meme stock saga continues, and it shows how detached from reality investors can get. A speculative mania that could have had detrimental consequences to our entire financial system.
With sharp increases at unpredictable times, what stock will the online community target next?
Image source: Pennystocks