Meme Stock Trading Strategy – Explained and Backtested
Meme stocks seem to be on everyone’s mind recently, with constant mentions in market summaries and analyses. These stocks gain traction on social media platforms, such as Reddit and Twitter (please follow us on Twitter), often sparking lively debate. While this is a new social phenomenon in stock investing, what is the meme stock trading strategy?
Meme stocks are stocks that have gained a cult-like following online via social media platforms, like Reddit, Facebook, and Twitter. The large communities of social media followers build hype around the stock through discussions and comments, which generate wide interest and investment in the stock.
In this post, we will take a look at the meme stock trading strategy, and at the end of the article, we prove a backtest of the strategy.
What is a meme in the stock market?
Memes are probably something you’re already familiar with if you use social media these days. A meme is a clever and amusing image that can be copied and adjusted to fit any situation. The idea is to express a concept using a single image and as few words as feasible. Following that, users of social media platforms disseminate these memes and help them go viral.
Many similarities exist between a meme image and a meme stock. Meme stocks are company shares that have grown immensely popular online and are traded on the stock exchange. Investing in meme stocks has a sense of humor as an underlying undercurrent. These investors are purchasing stock in a company that is not a smart investment and typically lacks a solid track record of successful business practices. It’s almost comical that they’re doing so.
The goal of creating a funny meme is to get people to participate in it somehow, whether through likes, retweets, or other means. The same is true for meme stocks, where retail traders try to persuade other investors to short the stock. When people buy stocks after hearing about them on social media, it might cause an artificial price increase, followed by an inescapable decrease. The buzz created around those stocks may trigger trading algorithms that use social media signals for trading.
Why is it called a meme stock?
The term “meme stock” was coined due to the rapid proliferation of ideas about meme stocks on the internet, including web forums and social media platforms. There have also been communities built around meme stocks, which keep spreading the word and adding to the original meme by making up their language and symbols.
A meme stock is not that different from any other asset in the same general category. It is a share of a public corporation that can be bought and sold on the stock exchange. On the other hand, meme stocks routinely receive a lot of attention. They are getting increasingly popular on social networks and online forums like Reddit.
The regulators may be concerned that what is now known as meme stock may not be much different from the pump-and-dump scheme of old, where a group of investors may choose to target a certain company and then pursue public investment in that company using this strategy.
How to find meme stocks? Where to find the next meme stocks?
You are most likely to find them on social media. We believe the most likely place is on Reddit.
Additionally, most of the meme stocks are based on a high short interest in the stocks. The aim is to create a short squeeze strategy in the stocks, ie, those who are short need to buy back their short position on higher levels.
What are the top meme stocks?
There have been several meme stocks since the term became popular at the turn of the decade. These are some of the top meme stocks:
GameStop (NYSE: GME)
The video game shop was founded in 1984, and it is a store that caters to clients who want to buy video games, consoles, accessories, and a variety of other connected things. In addition to its more than 4,500 physical stores, this retail store has an online store. GameStop stock was originally traded on the New York Stock Exchange in 2002.
At the start of 2021, it began to explode, and the community quickly became excited, causing the meme effect to affect its price. The share price was $17 at the time, but after the buzz, it jumped to $325, marking an 1800% gain. Previously, the price per share was $17. Because the stock price fell to $50 per share during the first several days of February, the frenzy lasted barely two weeks. Midway through March, another meme run began, resulting in the share’s price reaching an all-time high of $265 at one point.
Tesla (Nasdaq: TSLA)
This company was founded in 2003 and has been involved in various initiatives since then. They work on electric vehicle development, manufacture, leasing, and retail sales. Tesla also produces energy generators and storage devices.
In 2021, the company signed a supply arrangement with Arevon, the most successful renewable energy provider. The amount of interest expressed by investors online substantially impacted the stock price. October and November 2021 were historic for Tesla since the business had the highest 12-day rise in stock market history. A rumor that Tesla’s market value had reached $1 trillion during that period caused a rise the following day. The price reached an all-time high of $1137 per share in November. Tesla’s online following and media sensation drive its price more than the company’s value.
Nio (NYSE: NIO)
In China, Nio is the industry leader in premium smart electric vehicles. They are involved in designing, producing, and marketing electric vehicles. In addition, they are focused on developing their technology for driverless vehicles. When Nio debuted on the public markets in 2020, each share cost slightly less than $4. During October and November, the price of the shares hit around $54 with a lot of media sensation. The return on investment exceeded 1,250%, which was outstanding. In January 2021, the price of a share of stock climbed once more, hitting $62.
Nio’s market value grew to $75 billion due to the stock price gain, putting the company fifth on the list of the world’s largest automakers by market capitalization. A share of stock is now priced at $20.82, with the chance of rising considerably higher.
Snap (NYSE: SNAP)
Snap is the company that owns and operates Snapchat, a social media network. Most of Snapchat’s revenue comes from online advertising, which represents 99% of the company’s overall cash flow. Snap debuted on the public stock market in 2017 with a share price of $27.
In 2020, the price reached an all-time low of $5 per share, the lowest price for Snap ever. It peaked at $83 per share in 2021, which was its all-time high price. Apple’s new privacy enhancements resulted in a large drop in income for all social media apps, despite that Snap’s revenue for the first quarter of 2022 was $1.06 billion. The stock has a huge online following, with many discussions on Reddit.
The next meme stocks – any possible to find? (Meme stocks for tomorrow)
Various equities have garnered cult-like followings on various social media platforms. The enormous trading volume of these securities can be attributed, in large part, to the multitude of retail investors looking for quick profits in options bets. Meme stocks have enjoyed extraordinary increases in trading volumes over the last year due to either stock purchases or option bets.
A few stocks are absolutely worth watching for those looking for the next big meme stock. These three stocks may be on the radar of social media communities:
GameStop (GME)
One of the most extraordinary short squeezes ever witnessed occurred when GME stock increased dramatically over the past year, moving its shares from around $4 in the middle of 2020 to more than $480 per share in January 2021. Given it 4-1 stock split in July 2022, the price of a share of the stock is much lower now and may be in the mind of social media traders.
The Kroger Co. (NYSE: KR)
The Kroger Co. is a food retail company that operates in the US and is based in Cincinnati, Ohio. The company operates food and drug stores, multi-department stores, and price-impact warehouses alongside marketplace stores.
The stock has been getting media attention recently, and many analysts have upgraded their views on the stock from Neutral to Outperform.
Microsoft (MSFT)
There is a likelihood that the number of retail investors interested in Microsoft and other mega-cap equities will grow dramatically. This is because, due to declining stock values, the share prices of many firms, including Microsoft, have fallen dramatically. As a result, many retail investors now see these companies more favorably.
Microsoft’s sales increased by 13% in the most recent quarter compared to the previous year. When compared to the company’s size, that expansion was rather spectacular.
Is Reddit = meme stocks?
More or less, yes.
This is because discussions on sites like Reddit drive attention to such stocks, giving them unexpected increases in popularity.
In Reddit, subforums like the WallStreetBets are focused on discussing stocks. Retail investors meet and discuss issues bordering on many aspects of different stocks, including the activities of institutional investors. In such forums, they hatch the plan to mass-invest in specific stocks, triggering short squeezes. An example was the GameStop short squeeze that forced Hedge fund Melvin Capital to close out its short position in GameStop with a huge loss.
Reddit meme stocks are becoming more popular, especially among younger investors who want to feel like entrepreneurs. However, there is a lot of risk in such stocks, as the prices can go from heaven to hell in a matter of minutes.
Meme Stock Trading Strategy backtest – does it work?
It’s challenging to backtest a meme stock trading strategy (for obvious reasons).
But let’s look at one of the factors that meme stock traders look at: the short-interest ratio. Does it predict future returns?
It does:
High short interest is followed by weak returns. This is the opposite of the meme stock trading strategy. Thus, it’s challenging to pick the very few meme stocks that go on to become multi-baggers. The average and median stocks with a high short-interest ratio do not become meme stocks.
We have covered the short-interest ratio in detail earlier:
Using sentiment analysis on Reddit to predict meme stock returns
Can you use sentiment to predict meme stock returns?
A recent study called Using Sentiment Analysis on Reddit To Predict Stock Returns published at the University of Gothenburg, concludes positively:
We find that the sentiment of WallStreetBets does have significant correlation with meme stock returns within our sample. Our results show significant differences between the examined meme stocks and non-meme stocks. Despite not being able to prove a causal relationship between the WallStreetBets activity and meme stock returns, we consider our findings promising for further research.
- Love Nilsson and Max Andersson Wikingsson
This is not the only study that confirms that you can use Reddit sentiment to predict meme stock returns:
- Reddit and returns: Analyzing the effect of stock sentiment on stock returns with FinBERT on Reddit text by Julian Poungratz
- Can Reddit Predict the Stock Market? by Melina Mackey
Because we are not involved on Reddit and in trying to find the next meme stock, we don’t have much research to offer.
However, like with most trading strategies, you need to go out there and be a little street-smart, not book-smart, and do some trial and error.
List of trading strategies
We have written over 1200 articles on this blog since we started in 2012. Many articles contain specific trading rules that can be backtested for profitability and performance metrics.
The trading rules are compiled into a package where you can purchase all of them (recommended) or just a few of your choice. We have hundreds of trading ideas in the compilation.
The strategies are taken from our landing page of trading strategy types.
The strategies also come with logic in plain English (plain English is for Python trading and backtesting).
For a list of the strategies we have made, please click on the green banner:
These strategies must not be misunderstood for the premium strategies that we charge a fee for:
FAQ
Let’s end the article with a few FAQ:
What are meme stocks?
Meme stocks are shares of publicly traded companies that are promoted and bought by internet communities, often for humorous or ironic reasons.
What drives the price of meme stocks?
The price of meme stocks is driven by the collective buying and selling decisions of individuals and retail investors, who are often motivated by social media trends, news, and rumors.
What are some examples of meme stocks?
Examples of meme stocks include GameStop, AMC Entertainment, and BlackBerry.
Are meme stocks a good investment?
It’s hard to say whether meme stocks are a good investment or not, as their prices can be highly volatile and unpredictable. Investing in meme stocks should be approached with caution, as there is a high risk of losing money.
How do I invest in meme stocks?
To invest in meme stocks, you need to open a brokerage account, deposit funds, and then buy shares of the desired stock through your broker’s platform. It’s important to thoroughly research the company and understand the risks involved before investing.
What is a meme stock trading strategy?
A meme stock trading strategy refers to a method of investing in stocks that have gained popularity due to social media buzz, internet memes, and online forums. The strategy is often associated with individual retail investors using online platforms to coordinate buying efforts and drive up stock prices.
What are some risks involved in using a meme stock trading strategy?
The risks involved in meme stock trading include the possibility of market manipulation, rapid price swings, and financial losses if the stock price does not continue to rise as expected. Additionally, meme stocks are often associated with low-quality or speculative companies, which can make them more volatile and prone to sudden declines in value.
Is a meme stock trading strategy a good idea for long-term investing?
No, a meme stock trading strategy is not a good idea for long-term investing. It is a speculative and short-term approach that is not based on fundamentals or long-term growth prospects. It is recommended to do thorough research and base investment decisions on a company’s financial health, management, and market conditions, rather than on social media buzz or internet memes.