In the current market climate where market returns disappoint expectations, investors can easily fall for the hype around speculative investments that promise high yields. However, investors should also be careful not to get caught up in a trading frenzy in fear of missing out on the latest buzzing stocks. While some people may get lucky from time to time picking individual stocks, the odds make it more like gambling than an investing strategy.
Even the most seasoned investors grapple with stock-picking
Just because stock prices have been climbing doesn’t necessarily mean they will continue to do so. Perhaps the biggest risk to consider when betting on stocks that have recently had a good run, is that the positive sentiment and artificial hype around them overshadow the real valuation and outlook of the actual business. You may be paying for the popularity of the stock, rather than for what the business is inherently worth. When the hype is finally over and the stock eventually goes back to ‘normality’, investors could see share prices plummet, and they may not recover in the short run (and in some cases, ever).
Understanding the GameStop frenzy
Consider the case of GameStop, an American-based video game retailer whose shares spiked when stock market pundits on Reddit noted that some hedge funds had taken large short positions in the stock. When you sell a share short, you sell a stock you don’t own. Eventually, actual shares must be bought to offset the short position. If the price goes down, the short seller buys the stock at a lower price, making a profit. If the price rises, however, the short seller will make a loss, since they will have to buy shares back at a higher price. Thus, the decision to intentionally drive share prices higher could force large losses for hedge funds, since they would be forced to buy the shares at higher prices to close out their short positions and prevent further losses.
Bloomberg data shows that by the end of January 2021, the stock price of GameStop had shot up to over $480 from $6 in just a few weeks. That’s a gain of approximately 5 300%. However, although the Reddit-army succeeded in forcing some hedge funds to realise large losses, the inflated share price couldn’t be sustained, since it wasn’t based on any fundamental valuation.
On 5 February 2021, just five days after recording one of its best days on record, GameStop concluded its worst week in history “as a reversal of fortune wiped out $18 billion from its stock-market value,” Bloomberg reported. The stock plunged 80% from $483 to $63.77 in a week, marking its biggest decline on record. The sharp increase in the prices of GameStop shares was unwarranted, resulting in a sharp pullback within a short period.
Local investment schemes are on the rise
Recent media headlines indicate an increase in dubious and unregulated investment schemes locally, too. Praesidium, Imagina and Mirror Trading International (MTI) are just some of the cases making headlines. In a market where consumers are pressured and traditional investment returns are lower than expected, it’s easy to succumb to the promise of high “guaranteed” returns these unregulated products offer.
Stick to your long-term investment plan
While many investments advertise higher yields, we caution investors to resist the urge to jump onto the latest trading frenzy in fear of missing out on potentially big returns. The yield may look attractive, but if you cannot explain why it looks attractive, you should rather avoid them. Sticking to a long-term investment plan provides a buffer for your investments in the face of various market conditions. A sound investment plan, patience and discipline go a long way in wealth creation.