What Are Cult Stocks And How Should You Trade Them?

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What Are Cult Stocks And How Should You Trade Them?


 

Browse through any major finance website, and you will likely see a post about “cult stocks.” If you are new to stock trading, this might be very confusing. Are they talking about a company engaging in evil activities?

Well, the reality is much simpler.

The term cult stocks refers to stocks that enjoy a devoted, vocal base of investors who are extremely bullish of company’s potential in future despite of disconnect between its fundamentals and stock price.

It’s the same idea as a “cult movie,” which refers to a movie that has developed a small, but important and absolutely dedicated, fanbase that grows bigger over time.

Keep reading for a deeper understanding of cult stocks and some of the ways you can trade these types of stocks.

How a stock becomes a cult stock

Generally, a stock is said to be a “cult stock” if it is changing hands based on market enthusiasm and sentiment as opposed to traditional market fundamentals.

Cult stocks tend to be thought of as infant stocks and often stay dormant for a long time. These stocks are followed by traders for years in anticipation that a huge payday could be imminent.

Examples of cult stocks

GameStop

GameStop (NYSE: GME) is a perfect example of a cult stock. Shares of the video game retailer are trading at levels no one could have imagined a year ago.

The stock has gained more than 1,363% so far in 2021, helped by millions of small traders who ganged up on Reddit forum WallStreetBets to drive momentum in the stock and squeeze large institutional investors short the stock.

Had you put $5,000 in shares of the company this year, you could have plenty to smile about: $73,166 to be precise.

Yet, stock traders and analysts are not expecting GameStop to post any profit this year and next year. Revenue growth is slowing as fewer gamers need to head to physical stores (or even shop from online retailers) when they can download new games straight to their consoles, PCs, tablets or phones.

While GameStop’s fundamentals may one day matter again, for now the stock has become the greatest show of force by ordinary day traders in a stock market that looks more like their plaything every day.

In recent months, GameStop has undergone a massive executive shakeup at the direction of former Chewy (NYSE: CHWY) chief executive Ryan Cohen, who invested a lot of money in the video game retailer last year and joined its board in January.

According to Wedbush analyst Michael Pachter, GameStop became a “cult stock because of Ryan Cohen’s success with Chewy” and retail investors “appear confident that he can implement omnichannel initiatives that will materially grow their earnings.

AMC Entertainment

Like GameStop, AMC Entertainment (NYSE: AMC) shares have also had an incredible run this year, thanks to the Reddit-fueled trading frenzy.

A year ago, AMC was floundering. Now, its shares and market cap have rocketed so much in recent months that it could be added to the Russell 1000 by the end of June.

The movie theater chain was has significantly been affected by the coronavirus pandemic. AMC, the world’s biggest cinema operator, posted a loss of $4.58 billion in 2020 amid shutdowns and cancellations or delays of movies during much of the year.

The company warned in a filing with the U.S. Securities and Exchange Commission last year that it may run out of cash by end of 2021.

And yet, shockingly, AMC has become one the hottest stocks of the year as Reddit traders pile into it. Shares of the company have experienced wild gyrations in recent months and is up a remarkable 2,160% year to date.

BlackBerry

After taking GameStop and AMC on a wild ride, BlackBerry (NYSE: BB) is next the stock that Reddit’s r/WallStreetBets community seems to be targeting.

BlackBerry, the company behind the once iconic line of smartphones and pagers has seen its share price jump 136% so far this year. While that is nothing compared to the meteoric rise GameStop and AMC, it is the biggest gain BlackBerry has recorded in two years.

And, judging by discussions on r/WallStreetBets, interest in BlackBerry is swelling. BlackBerry shares are currently trading in the range of $15 to $16 per share, but the most enthusiastic traders are hoping to see the stock reach $50.

BlackBerry appears to be positioned in fast growing industries. The company is engaged in internet of things (IoT), car software and cybersecurity.

However, BlackBerry faces extreme competition in all the three industries from bigger, well-funded companies including Alphabet (NASDAQ: GOOG), Broadcom (NASDAQ: AVGO), and Cisco (NASDAQ: CSCO).

It’s also struggling to return to growth. The company reported net loss of $789 million and a revenue decline of 10% for the nine months ended November 30.

Tesla

Tesla (NASDAQ: TSLA) has been a cult stock for years. The electric automaker went public eleven years ago with a share price of $17. In 2020, the stock started around $90 and later staged a relentless rally with the price of a share in the company surpassing $2,000.

At the end of August, the company carried out a 5 for 1 stock split in order to bring down the share price to more affordable levels. The stock split gave existing stockholders four more shares for each one that they owned.

It was a great decision that saw shares of the California-based company surge another 40% after the announcement. As of this writing, Tesla stock is changing hands at $603 per share.

Much of the stock’s remarkable run can be credited to the seemingly boundless enthusiasm of CEO Elon Musk’s fans, for whom he is a hero.

But short-sellers have also played a role, too as many of them rushed to cut their losses after betting that the company would fail and that actually pushed the stock higher.

Trading cult stocks

Cult stocks are not found among the mainstream stocks that every trader knows and likes. These eccentric stocks can often be actively traded in heavy trading volume, but that volume is often seen on days when there is rumors or news weighing on the stock.

Then, they will sometimes experience large spikes in volume (into the millions of shares in a single day’s session) and the trading volume will remain solid in the subsequent days.

But generally, cult stocks don’t do very much volume on a daily basis and their trading volume average is often in the range of 50,000 to 150,000.

The key to trading cults stocks, of course, is knowing how to take full advantage of the stock market. Sometimes the conditions are so good for a stock to surge higher that it can balloon to unprecedented levels.

However, you also need to perform technical analysis to know when the top arrives. Moreover, keep in mind that the key to good trading is buying low and selling high.

Bottom Line

Cult stocks are perhaps one of the most intriguing of all the stock market areas.

While these stocks tend to be pretty low key, they can trade completely out of reality. A common rule in the U.S. stock market is that one should never fall in love with a single stock; always have an open mind.

But with some stocks, traders just can’t resist temptation: Strong belief in the long-term success of the company, the product, its mission can create a cult-like aura following for the stock, sending the price to unimaginable levels.



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