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FOMO: The pitfalls of investing too swiftly

In terms of investment, the "fear of missing out" can be provoked by a speculative environment or a third party wishing to sell a financial product. The consequences are sometimes catastrophic.

Reading Time : 4 minut(s) - | Published on 16-06-2023 16:10 

The fear of missing an opportunity, a psychological trigger to encourage buying

Common in the cryptocurrency sector, FOMO ("fear of missing out") is increasingly observed in the stock market as well as many investment products. This fear of missing a good opportunity, as a driver of action, can be triggered by a group of people with the goal to attract investors and drive them to purchase (sometimes to sell). Unfortunately, disappointments are often around the corner.

When utilizing the principles of FOMO, financial product vendors propose an investment offer that they describe as "unique" or "rare", "profitable" and which requires making a "very quick decision" lest it be missed. In the most common case, the investor notices that the market is high and then decides to invest immediately in the hope of not missing the opportunity. In reality, FOMO is a classic trap used in marketing to pressure prospects into paying immediately, at times when the conditions are not right.

The vendor's insistence - sometimes convinced themselves, sometimes motivated by commission and sometimes with ill-intention - leads the investor to position quickly without taking the time for initial analysis.

Sometimes, it's the persistence of the same erroneous or warped information across multiple media outlets acting as a trigger. A quote attributed to world-renowned investor Warren Buffet is particularly telling: "It's when my taxi driver tells me to buy a stock that I know it's time to sell it." In other words, when a financial rumor spreads among the general public, it is likely that the enthusiasm it arouses will provoke a strong but temporary movement on the concerned value.

In practice, anyone can be affected by FOMO, individuals as well as companies. However, the syndrome tends to manifest more among inexperienced investors. Yet, even those with more experience can get bewitched when seeking quick and significant gains.

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The snowball effect leads to an overvaluation followed by a collapse

The snowball effect is characterized by the continuation of positive signals over a period of time with share prices that continue to rise. The direct consequence of this effect is that more and more people buy, including those who are looking for high-growth securities with the aim of reselling and making a capital gain.

When a stock breaks away from its usual values on the rise, two scenarios can occur:

- either the financial security's value has genuinely jumped: this can happen during certain announcements such as new contracts won by the underlying company, filing a revolutionary patent, opening a new market... To know this, it is necessary to do some research by reading the company's announcements, as well as specialized press and the opinions of several analysts before forming one's own opinion;
- or a speculative bubble is forming. The interest of a growing number of investors attracts other investors who fear missing out and rush to the stock without taking a step back. The continuance of the movement leads to a bullish rally. The stock's valuation and its actual value no longer correspond. The risk of collapse is more than certain, it's just a matter of time.

In terms of a speculative bubble, the 2021 cryptocurrency market is a good example. Rumors sent Bitcoin over $100,000 by the end of the year. Many new investors entered when the cryptocurrency was trading between $50,000 and $60,000 to invest "before it's too late", aiming for a substantial capital gain.

This overpricing of Bitcoin then led to many other cryptocurrencies in its wake. In November, the bubble began to deflate. 6 months later, Bitcoin was only worth $20,000, returning to its level at the end of 2020. A person who invested €1000 in Bitcoin in mid-2021 ended up with only €330 a year later. By June 2023, their investment, valued at €445, has still lost more than half of its value.

Investing at the peak during a period of overheating, the devaluation of a stock can result in a significant financial loss. The stock price eventually reverts to its regular valuation either very abruptly during a crash, or over time. It is unsure that it will ever reach the same highs. A too hasty investment decision makes the investor a victim of the bubble.

The concept of "pump and dump"

The psychological effect of the FOMO syndrome can also be used to influence stock prices to increase their value.
In this matter, "pump and dump" is an (illegal) market manipulation technique.

The organizer's goal here is to sell at maximum price. Holding massive amounts of stocks or other financial assets, they circulate false news to spark interest among investors, artificially inflating the price. The promoters of this scam, who intend to profit from reselling, most often use spam campaigns, rumors on social media, or claim to have information unknown to the public, about an asset.

Once the asset value is at its peak, they sell and cash in the capital gain. The sudden increase in offer volume then causes the price to drop. Investors who bought these stocks at high prices due to excitement and FOMO then face heavy losses.

Tips to avoid the trap of FOMO

To avoid falling into the FOMO trap and identifying the risks of losing money linked to this phenomenon, it's important to adopt a number of protective measures. The first is to avoid investing during sudden upward cycles. These "opportunities" are mostly deceptive and the devaluation of the shares is a real risk of losing the invested capital.

The second measure is to avoid at all costs individuals who insist that you invest immediately, even (and especially) if the deal appears enticing. The premise that it's the "right" time to enter a market or purchase shares is a less than convincing argument that could at best hide incompetence and at worst, a scam.

Even if you want to take the plunge, take a step back: analyze investment offers, read contrasting opinions (technical and fundamental analysis) and assess the risks of each proposition before making a decision. Finally, adopt a long-term view. Sometimes, a simple step back can lead to the "joy of missing out": the satisfaction of having missed an opportunity.

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