The jury is still out on whether the meme stock trend is good or bad for the industry, but the topic keeps making headlines and the trading volume for meme stocks is significant. The market is volatile and unpredictable, so make sure you do your research before you invest.
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But what are meme stocks anyway?
Meme stocks took over mainstream media at the beginning of 2020 thanks to GameStop’s crazy rise on the financial market and its ever-looming short squeeze. Retail investors rallied together to make money at the expense of Wall Street short-sellers. For the past months, they’ve organised buying campaigns over social media to back some of the market's most shorted stocks and trigger short squeezes.
The unprecedented market activity of this year has not only established a new category of stocks, but essentially defined a new kind of trading strategy. When trading meme stocks, the decision to buy or sell is based not on a company’s performance but on the hype it receives on social media.
Meme stocks are characterized by high volatility and short-lived popularity, mainly fuelled by social media platforms. The focus is generally on heavily shorted stocks (stocks that short sellers bet on going down in price) that groups of retail investors decide to back in buying campaigns. Their goal is to force short sellers to close out their positions by buying shares of stock and thus pushing up the stock price.
When a stock has a lot of short interest (investors take short positions to benefit from that company’s likely downturn), there is potential for a short squeeze. This happens when some sudden good news about the company's prospects or just momentum created on purpose by a group of investors (as in the case of meme stocks) reverses the trend of the stock price, which pushes short sellers to close their position. They do that by purchasing shares from the market, all rushing to buy at the same time to cut their losses as much as possible, which pushes the stock price even higher, which in turn attracts more buyers.
There are a few patterns to look for when trying to find the next big meme stocks. Meme stocks commonly share the fact that they are heavily shorted. Oftentimes, stocks are skewed towards shorting when the company is believed to have no positive financial future. It’s these stocks that hedge funds short as a near guarantee for positive returns, and so they are potential targets for retail investors to try to push into a short squeeze through buying campaigns. Check Saxo's meme stock watchlist.
It might be a good idea to follow a meme stock watchlist and keep an eye out for the top movers. When trading meme stocks, make sure you set both stop-loss and take-profit targets to minimize your risk in highly volatile market conditions. A stop-loss makes sure you don't lose more money than you are comfortable with, while a take-profit guarantees a certain percentage of return when the stock price hits your set target.
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