With the recent price explosions of both bitcoin and GameStop and until just recently, some stocks in the biotech sector, it may be time to step back and take a look at the broader picture of why these events might be occurring.
It really doesn’t matter what the asset is. Instead, we should see if there is something more in play here than some stocks whose prices keep going up.
These types of explosive price moves certainly make for great headlines. Seeing a stock gain five, ten or fifteen percent day after day is rare, but when it happens, it attracts investors like flies to fodder.
It is more common to see price moves like this during over-heated and extended stock markets then to witness them during a crash phase. Think back to the dot.com era and investors saw similar astonishing gains during that mania as well.
We all know how that ended.
Simply put, when some crazy stock rallies like a rocket ship, some people make money. Usually the early arrivals to the stock party. Many of these events can go on much longer than what may seem reasonable. It is said among professional traders that “markets can stay illogical longer than you can stay liquid”. In other words, a stock that makes amazing gains day in and day out can continue to make these gains for longer than you might think possible. It is what makes these events so magnetic, and why even those late to the party can make some money. The very late arrivals however, usually only see the crash that follows.
What drives these events?
As markets rise, investors experience the euphoria of quick and easy money, and sometimes lots of it. Often the gains happen so fast, the participant starts thinking crazy things like becoming a permanent day trader, retiring at age 30 or setting their sights on nice round number like a million dollars.
Meanwhile “Mr. Market” sits back and grins, as these occasional manias are all in a day’s work. If Mr. Market could talk, it would say, “Wait for it”.
To say most of these events end badly for many is an understatement. The only thing that destroys more money faster than a stock mania is a Ponzi scheme, or something similar.
More importantly is to understand what is it about investor’s mindset that causes these ballistic rallies to occur in the first place.
With rising markets come loose lips, meaning the more stocks rise, the more money is made, and the more money is made, the more people talk about it. An investor gets to the point where everyone around them is claiming newfound riches and then the “FOMO” mindset (Fear of Missing Out) combines with the “greed’ DNA we all have buried deep within, and the trap is set.
Good sense is then tossed out the window, replaced by an investing APP on their smart phone or by opening up a brokerage account. A deposit check is close behind.
The “buy” button is then pushed, officially signaling a “let the games begin” moment.
Then the fun (or lack of it) begins.
Next time when this urge strikes you , instead of rushing out and investing your rent check or mortgaging your house, realize two things:
Explosive price moves are rare, and even more rare is that they are seldom driven by real fundamentals. It’s just a lot of people like you, all thinking and hoping for the same thing called “the greater fool theory”. Which is to say, some fool (go find a mirror) is buying something they know little about, in hopes another fool comes along (hence the “greater” label) and buys it from you. Just don’t be the last fool to enter the fray, and there will be many. They are the ones that usually get burned.
The second thing to think about, if you’re thinking at all during all of this, is that these types of manic stock buying events usually occur during extremely overbought and hyped up markets.
Which is to say, the market as a whole has probably lost its mind right along with you, and instead of writing a check, it may be time to cash one out instead.
Ignore at your own peril.
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