Meme trades could signal a market selloff

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SmartAsset's free tool matches you with fiduciary financial advisors near you in 5 minutes. Each has been vetted and is legally bound to act in your best interest. [Get started now.]( Sponsored --------------------------------------------------------------- Meme trades could signal a market selloff [El Presidente Stocks GIF by Barstool Sports] - Short squeezes started the meme stock frenzy - Now there is a lack of short sellers - Several indicators show too much market optimism - Options markets overestimated AMC’s earnings move by 100% No stock exemplifies meme investing more than AMC Theaters (AMC)... Okay, maybe GameStop (GME). We heard from AMC Theaters yesterday afternoon when they posted second-quarter results. What’s fascinating is the market’s reaction to the results. And it explains why this could lead to a market selloff. What caused the meme stock craze? Back in January, GameStop was flooded with buy orders from retail traders. Normally, they don’t have enough money to move the stock. This time, they had three new tools in their bag. - Traders used option contracts to leverage their capital. Each option contract allowed a trader to control 100 shares of stock for a fraction of the price. - They coordinated online. Reddit subgroup WallStreetBets made its debut in the mainstream media. - Large funds and investors sold the stock short, betting on the company’s collapse. Let’s dig into that last piece for a moment. Those bets are like the opposite of buying stock. The main difference is you could experience infinite theoretical losses as a stock’s price approaches infinity. You can only lose what you invest when you buy a stock. Shorting a stock requires margin, or borrowing from the broker. Many often do it with leverage. Back in January, GameStop had a 120% short float. Put simply - you had 20% more shares shorted than were available for trading. Mind-boggling right? Once buyers pushed the stock high enough, brokers initiated margin calls forcing short sellers to exit their positions to stem their losses. Short sellers bought stock to close out their trade, which sent shares even higher. That caused more short sellers to exit, and so on. Why this won’t happen Right now, GameStop’s short float is around 13.88%. AMC is at 22.8%. Both are much lower than even two months ago. In fact, general market short interest has gone down significantly. At the same time, we’re seeing hedge fund leverage at 4-year highs. Taken together, that means big money is more bullish than ever. And that’s a problem. You see, healthy market gains require a dose of skepticism. Short sellers, like forest fires, aren’t popular, yet are important to their ecosystem. Without them, you get runaway euphoria that leads to excesses in asset prices often followed by severe pullbacks. A bit more on AMC For stocks to make those massive runs, you need a lot of folks to be wrong. One leading indicator is the options market. Leading into an earnings announcement, options traders will price in the expected move of a stock based on that event. The options market priced in a $6.00 move for AMC based on earnings. So far, the stock has only traded +/-$3.36 from yesterday’s close. Said differently, the people who bought options were wrong by about 50%. It’s another sign that overall optimism has led to outsized expectations. Our hot take We all know they say buy when others are fearful and sell when they’re greedy. Our best proxy for that is excessive bullish (stocks heading higher) or bearishness (stocks heading lower). And to that end we leave you with one final graphic. These are the top ticker searches amongst institutional advisors from our proprietary database. And their top search for the last 3 weeks...heck the last two months...AMC...by a lot. To ensure delivery of all emails, [whitelist us](. You are subscribed to email updates from [InvestingChannel](. 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