Meme Stock Market Mania: Lessons From A MultiBillion Dollar Bubble

Paul Samuelson, one of the founders of neo-Keynesian economics, offers a sobering view of investing: “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”

We all want excitement in our lives, but while the stock market has it, it isn’t the type you need. The possibility of large profits is the first alluring aspect of investing in the stock market. Second, the excitement and difficulty: learning to navigate the market's myriad complexities can be like playing a strategy game in that it requires one to use their brain and emotions. Finally, a feeling of accomplishment: Gaining satisfaction and proving the value of your knowledge and abilities can be achieved through accurate market prediction and successful trading. Finally, market psychology is something to consider. People may feel as though they are playing a game due to the unpredictable nature of the market, where the excitement of winning and the possibility of future great success are highly alluring. Investors' enthusiasm stems from a combination of rational, emotional, and monetary considerations.

The Pandemic Meme Period

The stock market amplified the pandemic's already high levels of excitement and uncertainty. Investors viewed unpredictable markets as chances for substantial gains, which further added to the allure of the prospect of substantial earnings. Being homebound and with more time on their hands, many people found interest and challenge in the stock market. They eagerly participated in trading activities, driven by the peculiar circumstances of the pandemic.

New investors flocked to the market during the epidemic because of the easy availability of internet platforms for trading and the potential they saw. These inexperienced investors frequently found themselves navigating murky waters, their decisions influenced by a blend of logic and emotion. Like a high-stakes strategy game, the risks were high, and the benefits were significant if you played your cards well.

But there were also more dangers because of this setting. Market risks were masked by the excitement and appeal of possible rewards due to a combination of factors, including pandemic-induced volatility and the inexperience of many new investors. Many investors lost a lot of money because of this, particularly those who got into the market without proper research or planning.

Exhilaration, a will to succeed, and the prospect of huge gains drove the activities of stock market participants throughout the epidemic. Because they were inexperienced, ill-prepared, and enthralled by the prospect of rapid profit, many individuals unfortunately lost money. Investing requires a balanced approach involving knowledge, strategy, and emotional control due to the market's complexity.

Understanding Risk

Devoted followers of my writings are aware of my investment philosophy, which prioritizes risk management over profit and loss considerations. I always emphasize assessing the potential risks of an investment before contemplating its potential gains. This approach becomes particularly critical in the volatile terrain of the general stock market, where the thrill of trading can often obscure the reality of significant financial risks. The pandemic period accentuated this issue. It ushered in a wave of new investors, many of whom, unfortunately, placed little emphasis on risk evaluation. This mistake, along with the fact that the market wasn't stable during the pandemic, caused a lot of these new buyers to lose money. It's a stark reminder of how important it is to put risk assessment at the top of financial plans, especially when the market is unstable.

Overtrading

The temptation to overtrade or seek higher returns through riskier assets raises the possibility of unexpected losses, particularly in an environment where pandemic-related uncertainties are prevalent. This situation often led to investor complacency, neglecting thorough portfolio research and monitoring. Additionally, the reduced market liquidity in fast-moving names made efficient trading more difficult. These conditions highlighted the need for a cautious and well-researched approach to investing, emphasizing the importance of adapting strategies to safeguard against potential stagnation or losses in such unpredictable times.

Some "meme stocks," which grew popular on social media and online forums like Reddit's WallStreetBets, fluctuated substantially during the outbreak. Famous instances are GameStop GME Corp, and AMC Entertainment AMC . Due to social media buzz, tiny purchasers flocked to buy these companies' stock when they were struggling. In early 2021, GameStop stock achieved record highs, symbolizing this trend. After these meteoric gains, both stocks fell more than half of their value.

The Temptation to Chase High Yields

High-yield investments frequently drew in investors. However, these opportunities frequently mask greater risks. In such uncertain times, it was crucial for investors to meticulously assess the balance between risk and reward, recognizing that what appeared to be lucrative investments could, in fact, be traps with unforeseen dangers. This careful evaluation was key to making informed decisions and safeguarding investments against potential losses in a deceptive market landscape.

Zoom Video Communications ZM , Inc. exemplified a high-yield investment with hidden hazards. Zoom was a developing but less dominant player in video conferencing prior to the pandemic. On the other hand, Zoom's services experienced an unprecedented upswing in demand with the advent of remote work, which in turn drove up its stock price. Investors pursuing high returns in a generally stagnant market were drawn to this. However, concealed hazards surfaced, such as heightened rivalry from technology behemoths improving their individual video conferencing platforms, ambiguities regarding the long-term viability of Zoom's expansion following the pandemic, and apprehensions regarding security and privacy matters. The share reached a high of around $480 and now languishes at $70. Investors who bought that high and are still holding it are now sitting on an 85% loss.

The Pitfalls of Emotional Decision Making

The epidemic was a perfect illustration of how investors might make foolish decisions because of their emotional responses to short-term market changes. The stock market went through a lot of ups and downs during that time, with several industries seeing a quick recovery after steep drops. This wildly unpredictable conduct rattled the nerves of many investors, especially the less seasoned ones. Those who let their emotions get the best of them in the face of these temporary failures frequently acted rashly, selling off assets at a loss out of panic or fear. Their original financial plans and long-term goals were usually disregarded in such cases. The period drove home the significance of remaining disciplined and dedicated to one's goals over the long term. To survive the storm and profit from the market's ultimate recovery, investors needed to be able to keep their cool in the face of short-term market swings while remaining true to their initial strategies.

Disregarding the Need for Quality Research

The era's emphasis on thorough research to inform investing decisions was on full display in a market that was unprecedentedly dull and uncertain. Many investors, caught off guard by the pandemic's impact on world markets and economies, rushed to react based on gut feelings or popular opinion rather than thorough research. Because the market during the pandemic was so complicated and called for a more detailed analysis, this strategy backfired for many. Industries such as tourism and hospitality, for example, have shown signs of recovery but have also posed serious threats owing to continuing travel restrictions and shifting consumer habits. Poorly informed judgments and possible losses were common outcomes for investors who depended on superficial trend-based research and failed to see these crucial nuances. People who took the time to study the pandemic's effects on various industries and businesses were able to make more informed decisions.

Neglecting Portfolio Diversification

The need to invest diversifiedly was highlighted by the epidemic, which is a lesson that can be applied globally. Having a diverse financial portfolio is like having a safety net; it can help you weather unexpected storms like a pandemic. The pandemic hit those who had all of their eggs in one basket or sector particularly hard. It was the same as realizing that some parts of the economy, like healthcare and technology, were booming while others, like energy and transport, were chugging along. Like how getting overly focused on one area of life might leave you vulnerable to unanticipated events, it became clear that failing to diversify one's finances could lead to more serious losses. Thus, just as we diversify our investments across multiple assets to weather life's inevitable ups and downs, the epidemic taught us the value of doing the same.

The Remedy

Investors have learned a lot from the pandemic and how it changed the stock market. Paul Samuelson, the economist we started out with, said that it's important to put risk assessment ahead of profit factors when dealing with uncertainty. It's important to stay disciplined during rough times; don't let short-term changes in the market make you make emotional choices. Think about long-term goals instead. Before making an investment, you should always do your homework, but this is especially important when the market is volatile. Spending this initial time before running away with some fantastic upside you probably won’t achieve is putting together a safety net that will protect you in case of another unforeseen event or sudden slowdown. Finally, don't give in to the urge to look for investments with high yields; they often hide bigger risks. Investors can better manage the complicated world of finance and protect their investments against losses they didn't expect by using these solutions.

Gamestop, Meme Stocks, and Deep Value Investing with Rod Alzmann