In our last article “Do’s and Don’ts of Investing in 2021”, we spoke to watching out for the FOMO (fear-of-missing-out) mindset, we used an example of this around the Bitcoin phantom rallies expecting to take place in 2021. This, however, is not the only place we can expect to see these events taking place. We believe it is important for our clients to understand more about the FOMO phenomenon. This is an age-old concept with a die-hard determination to trip us up and it does not seem to be fading out any time soon. So best we become well acquainted, understand how to identify it and know what to do when we are faced with it. Empowering us to make wise and informed financial decisions that your future self will thank you for.
HOW TO SPOT IT
Usually, the market shows a sharp V-shape climb, with little-to-no reason as to why. Investors see this and start to wonder “When is the best time for me to enter at the best price?” and in turn, trying to time the market begins to play in their minds. A publication by Real Money stated that “the best way to deal with FOMO is to be aware that it is going to occur no matter what you do.” The very nature of the stock market is to be unpredictable and untamed. It can serve us up a lovely piece of humble pie rather unexpectedly. “We will never feel we have made the absolute best choices because the market is always going to act in unpredictable ways.” – James Deporre.
Rather than focusing on what we are missing, we should be focusing on what we are doing. Pause and ask yourself; “Is this a chart I would normally buy or am I more inclined to buy it because I fear missing out?”… “Am I making my decision purely based on chasing a high-flying asset or are there other facts and numbers that can quantify or qualify my decision”
WHAT THE FOMO PHENOMENON IS
The market is largely made up of people and algorithms designed to track trends taking place in the market. The fear of missing out (FOMO) effect compounds the more the market continues to act irrationally with buying and selling. Why does it compound? Remember, the market is made up of humans with emotions and machine algorithms with none. There are many ways in which these two interact with one another causing various market responses. However, one interaction we would like to highlight is when human emotion feeds the trend because of fear of missing out. It would look something like this:
Fear of not taking part in a market rally starts in the heart of human emotions. This causes them to react, usually buying or selling securities and shares irrationally. In turn, this creates movements in certain security and share prices. If these movements are large enough it catches the attention of algorithms designed to take advantage of these kinds of emotional responses. In true machine-spirit it jumps onto the trend, pushing prices higher, feeding human emotion more and so the cycle continues.
Not all algorithms are designed this way. Many are programmed to analyse a security or share’s true value using quantitative analysis, ratios, a variety of instruments, and investment theory. This is why asset managers can make the bold statement of “this is just a bubble”. They can see that there is no calculated reason for the share price to be so high. The investment to that security or share is flagged as an unattractive risk-to-return ratio and is marked as an emotional rally.
The market does play on emotions. After all, we are trusting it with our hard-earned capital. Being emotional about what it decides to do with our capital is tempting, but we need to keep our wits about us.
If an investor wants to give in to FOMO because they enjoy the thrill, then they should at least make sure risk management is taking place by diversifying their assets. In other words, hold a variety of different investments so that if all goes pear-shaped because of a short-term FOMO moment, there are at least other investments that are strongly stayed on course for long-term wealth creation objectives with strategic and tactical allocations.
– Cephas Dube, Wessel Grobler & Kheara Lugg