How to Trade Meme Stocks
Meme stock trading has become a very emotional topic for a lot of traders. If you’ve been trading for a long time, then chances are, you think of meme stocks as a joke or a passing fad that won’t be around for much longer. If you’re brand new to markets, then you probably want to know how you can find the next big viral meme stock and make even more money trading it.
No matter where you fall on this topic, it’s very likely that this viral approach to trading is going to be around for a while longer. This is why I think it’s important that we all understand the psychology behind investors of meme stocks, and how to sustainably and responsibly trade meme stocks for the long haul.
If you’re someone who isn’t really sure what meme stocks even are, then keep on reading because we’ve got you covered as well.
I recorded this response in video format first, which goes more in-depth than this article, so if you prefer to sit back, relax, and watch instead of reading, hit play on the following video. We also have timestamps in the description of the video in case you want to jump around.
What are meme stocks?
The Balance has a simple one sentence definition for meme stocks:
A stock that has gone viral online, drawing the attention of retail investors.
An example that you might be familiar with is GameStop. You have probably heard about it recently with its rise to the Meme Stock spotlight at the beginning of 2021. Some other popular meme stocks are AMC and Blackberry.
Where to find meme stocks?
If you’re wondering where traders might be finding meme stocks, they’re probably getting their information from a subreddit by the name of WallStreetBets, which is where the Meme Stock gold rush originated from. They’ve been around since 2012 but have recently gained a massive following over the past 18 months, now having over 10 million subscribers (June 2021).
Another platform that has been rising in popularity amongst traders is Discord. Discord is a social application where you can communicate and collaborate with people and form communities. The app has been mainly used by gamers but a lot of people are starting to use it to discuss the markets and meme stocks. Like Reddit, Discord is another source to discover these hot new trending stocks.
Why are people investing in meme stocks?
There are a few big tail winds at work here giving rise to meme stocks.
First and very simply, the improvement in technology has made it so much easier to share ideas, collaborate, and grow large online communities. It has become so simple to connect with people from anywhere around the world faster than ever before.
The COVID-19 crisis, also accelerated the number of people not working, or working remotely, which means more time spent on social platforms, paying attention to finances, stocks, and investing.
Finally, and probably most importantly, the younger generation that’s just getting started in markets, view meme stocks as a fun activity. It is a social movement that’s happening along side online gaming, sports betting, and crypto markets, and retail traders are joining together to invest alongside their friends.
Trading meme stocks tip #1: Position Size
One of the biggest issues I have with new traders investing in meme stocks is the amount of risk they are taking on when they buy into one of these stocks. If you spend more than 5 minutes looking through WallStreetBets, you’ll quickly realize the attitude is to be all-in, leveraged, and shooting for the moon with diamond hands.
Having conviction has its place when investing, but blindly being all-in or having strong conviction in every single idea is a recipe for disaster. If you’re trading meme stocks, it is crucial to be responsible with the amount of shares you purchase (position size).
Why? Because these stocks can easily experience 70% or greater drawdowns that will destroy your account, or even worse, take you to zero if you’re investing with options.
For helpful information regarding position size, read our article How to Position Size When Swing Trading. You can also use our Position Size Calculator on our website to help you level up your trading and invest more responsibly.
Trading meme stocks tip #2: Have an exit point
Buying is the easy part.
Anyone can open up their Robinhood app, type in the latest hot ticker from r/WSB, and submit a buy order. In a matter of seconds, you’re now a shareholder! That’s exciting, but now the real question that you need to ask yourself is: when are you going to sell?
Are you going to sell if the stock doubles in price? How about if it gets cut in half? You need to have a pre-determined exit point mapped out before you get involved in the market.
In our YouTube video around the 16 minute mark, we share a few techniques on answering this question:
- You want to participate when the times are good (positive price momentum)
- Be much more cautious when prices start declining and stocks start pulling back
Trading meme stocks tip #3: Selling partial shares into strength
Let’s continue on with this topic of risk management and controlling the amount of dollars you have invested.
Meme stocks move fast — really fast.
We saw the popular meme stock GameStop soar 20X in price in a matter of weeks at the start of 2021. That’s an absurd gain in a short amount of time. If you find yourself in one of those very fortunate situations you should strongly consider selling some of your shares into that rally.
A lot of new traders think that it’s a binary decision to be all in or all out of the market. But that’s not the case at all.
If you have 50 shares of a stock, you can easily sell 10 or 15 shares after they’ve appreciated far beyond your purchase price. Doing this, ensures that you’ve pulled your original investment out, which means you’ll sleep better at night knowing you have some gains secured.
You can then use those funds to get ready for your next trade.
Why experienced traders should pay attention to meme stocks
As much of a joke as this space looks like to old time traders, there is a lot of money making potential in these types of stocks, especially for experienced traders that understand price action, market structure, and market psychology.
Have you considered having a watchlist dedicated to the hot meme stocks and tracking them for low-risk high reward price action setups? We know meme stocks have captured the attention of millions of investors and traders around the world, so when a highly talked about name starts to breakout and surge higher, you can be ready to capitalize on these bursts of momentum.
How about after a stock has run up 10X in a short amount of time and option premiums are through the roof?
Experienced traders should embrace the new culture of meme stock investing and look for ways to incorporate them in their own strategies.
How to trade meme stocks — In summary
I don’t think we’ve seen the last of the meme stock investing era. I expect many more epic stock rallies and subsequent crashes in the future, and it’s sure to make for some juicy headlines and stories.
I also think meme stock investing is a net positive for the industry to get young investors interested in the stock market. Experienced traders, Bogleheads, Warren Buffet disciples, are all going to frown upon this movement, but it’s important to remember that every investor needs to start somewhere.
Hopefully the tips laid out in this article will help first time investors trade the market a bit more responsibly and start thinking about risks and risk management.
What are your thoughts on this topic? Have you been trading meme stocks? Leave your thoughts below, I’d love to read them!
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Posted in Article, Risk Management, Trading 101, Trading Education
Tagged with Discretionary Trading, Position Size, Swing Trading, Trade Setups, Trading for Beginners, Trading Psychology
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