The Rise of Meme Stocks: How Social Media is Turning Stock-Investing into a High-Stakes Game

While faster and more accessible ways to trade stocks may provide new opportunities, they don't necessarily improve market efficiency. Social media-driven trends like "Meme Stocks" add volatility to the stock markets, prompting experts to suggest that reacting to short-term social-media inspired sentiments can undermine accurate share price valuations, ultimately resulting in decreased market efficiency. 

Stock markets are arguably quite efficient today, with near-24-hour trading and real-time availability of information relating to a company via online platforms like Reddit, Twitter, and Discord.  However, does the ease of accessibility to current information and the lower costs associated with stock trading reflect a more accurate value of a company’s worth? Furthermore, does it really translate into more efficient markets?

Today’s markets are probably the most nimble they have ever been. Trading algorithms can quickly gather and sort relevant information coming from a range of news sources as well as high-frequency trading, where traders can transact in a fraction of the time it used to take  (Hombert, 2015).  Does this lead to more efficient markets where resources are accurately allocated or simply speedier, more sophisticated-looking trading methods?  

According to the Efficient Market Hypothesis (EMH), share prices reflect all available information with stocks always trading at their fair value on exchanges (Downey, 2024). Proponents of EMH believe that it is impossible for stocks to deviate from their fair market values, especially with the increased speed and dissemination of information about any stock so readily available to investors. 

However, many prominent financiers believe that contrary to expectations of increased efficiency brought about by advancements in technology, the stock market has actually become less efficient. Clifford Asness, a hedge-fund manager and financial researcher, asserts this by using an example of a portfolio of stock prices over the last 30 years (2024, p.1). 

One might assume that the increased ubiquity and speed of trading are reflected in the efficiency of markets, however, that would “be mistaking speed for accuracy”, according to Asness (2024, p.4). Further, he contends that “Speed doesn’t imply the level of prices before or after the new information was particularly accurate or not” (2024, p.4). New information does impact stock prices faster than in the past and this may be considered a type of efficiency. Still, Asness argues that in the medium term, it is largely irrelevant and accuracy has decreased (n.a, 2024). By looking at the “value spread”, which is the ratio of the valuation of expensive stocks to cheap stocks, investors can gain insights into market sentiment and valuation trends. A high-value spread indicates that expensive stocks are significantly overvalued compared to cheap stocks. Conversely, a low-value spread suggests opportunities for investors to capitalize on undervalued assets (Asness, 2024, p.4).

Asness does not believe that prices have accurately reflected reality when looking at the value spread of a cross-section of stocks over the last 30 years.  Instead, he offers a hypothesis based on the emerging importance of social media on stock prices. Indeed, “instantaneous, gamified, cheap 24-hour trading” has made markets less effective at accurately pricing stocks with popular stocks soaring and plummeting with no real relationship to their actual value or underlying fundamentals (Cazzin, 2024). 

Warren Buffett stated that stock markets now exhibit far more “casino-like” behavior as independent crowds turn into “coordinated clueless mobs” as retail traders have their biases reinforced by online forums, creating economic bubbles (Asness, 2024, p.13). When these bubbles occur, they inflate the prices of certain assets or sectors far beyond their intrinsic value, diverting resources away from more productive uses. 

The internet has broken down many barriers that once made trading inaccessible, challenging the notion that one must have formal education or substantial capital to participate in the stock market. Online platforms such as Reddit’s r/WallStreetBets simplify complex investment language into relatable terminology or content, often using memes. This phenomenon has given rise to a movement known as “Meme Stocks”, where retail investors leverage social media to influence stock prices. This translates to extreme price volatility for meme stocks that are not necessarily tied to the company’s actual value (Cazzin, 2024).  

A notable meme stock frenzy occurred in 2021 following Keith Gill's (“Roaring Kitty”) analysis of GameStop, as GameStop gained phenomenal traction among retail investors.  Institutional investors had initially predicted the stock value to decrease based on its fundamentals, and many were short-selling the stock, however, the number of retail investors trading GameStop rose suddenly and drastically with a resulting share price increase of 700% in 2021 (Zahn, 2024). This phenomenon was led by retail investors using the Robinhood Financial platform, organized via a chat forum on Reddit (Malz, 2021). Although Keith Gill was able to turn an initial US$53,000 investment into $50 million, many retail investors lost out because they invested too late (Salvucci, 2024). 

Timing the market is one of the most difficult things to do, and as a retail investor, it makes more sense to go with lower-risk options and to avoid falling into the mob mentality associated with Meme Stocks. As Zachary Diaz, an investment analyst puts it, “Meme stocks are not meant to be held for long periods of time, so they are not an efficient vehicle to preserve wealth and it almost undermines the goal of investing as a way to preserve and grow capital.” (Diaz cited in Cazzin, 2024)

As the popularity of these stocks is driven by online emotion, meme stocks exponentially increase the time-sensitivity of trading. If you misjudge the timing, it is unlikely you’ll make money (Cazzin, 2024). Moreover, since much of this information is coming from anonymous users with “NSFW pseudonyms”, it is essential for investors to approach such advice with skepticism (Asness, 2024, p.12). 

What should retail investors do when faced with the increased volatility and inefficiency of stocks? Cliff Asness suggests focusing on long-term investments, diversifying your portfolio, not overreacting to market volatility nor trying to “time the market” and to stay informed but avoid an overload of information (2024, p.17). A meme stock world slogan “Hold on for Dear Life” is actually a sound strategy when applied to high-quality investments that you believe in long-term. Investors should push themselves to have the longest possible investment horizon (Potter & Lee, 2024). Staying committed to well-researched companies or diversified index funds can help weather market volatility (Asness, 2024, p. 18).

References

Allan M. Malz, The GameStop Episode: What Happened and What Does It Mean?, Cato Journal, 2021, https://www.cato.org/cato-journal/fall-2021/gamestop-episode-what-happened-what-does-it-mean

Clifford S. Asness, The Less-efficient Market Hypothesis, SSRN, 2024, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4942046

Jeremy Salvucci, Keith Gill’s net worth: How much did the 'Dumb Money' investor make on GameStop?, TheStreet, 2024, https://www.thestreet.com/investors/keith-gill-net-worth

Johan Hombert, The Role of Speed in Today’s Financial Markets, HEC, 2015, https://www.hec.edu/en/role-speed-today-s-financial-markets

Julie Cazzin, Hard earned truth: Meme stocks won’t make you rich, Financial Post, 2024, https://financialpost.com/wealth/smart-money/hard-earned-truth-meme-stocks-wont-make-you-rich

Lucas Downey, Efficient Market Hypothesis (EMH): Definition and Critique, Investopedia, 2024, https://www.hec.edu/en/role-speed-today-s-financial-markets

Max Zahn, GameStop stock is soaring again. Here's what to know., ABC NEWS, 2024, https://abcnews.go.com/Business/gamestop-stock-soaring/story?id=110771446#:~:text=In%202021%2C%20the%20price%20of,chain%20of%20video%20game%20stores.

N.A., Has Social media broken the stockmartket?, The Economist, 2024, https://www.economist.com/finance-and-economics/2024/09/05/has-social-media-broken-the-stockmarket

Sam Potter & Justina Lee, Cliff Asness Is ‘Old Man Whinging’ as Markets Get Less Efficient, Bloomberg, 2024, https://www.bloomberg.com/news/articles/2024-09-03/cliff-asness-is-old-man-whinging-as-markets-get-less-efficient?embedded-checkout=true