Your friend was talking about it, that seemingly trustworthy influencer on Twitter has been posting on it.
They made so much money with that stock, it could have been you. You buy it without doing much research on its fundamentals, then the share price starts falling.
Your fear of missing out somehow resulted in missed gains and probably trading losses.
This is one example of a cognitive bias, a group of often-overlooked psychological traits that can influence how we think and behave as investors.
Cognitive biases can lead to making decisions based on ideas that may or may not be true.
There are various types, from confirmation bias – looking for information that supports your thesis, discarding facts that would debunk it – to gambler’s fallacy, which involves looking at share price movements and expecting them to adopt a pattern similar to the past.
Status quo bias is taking decisions based on existing habits, without looking at new stocks; risk-averse bias pushes investors to focus too much on the safe and conservative stocks.
Finally, the bandwagon effect is the opposite of what Warren Buffett swore by, so instead of being “fearful when others are greedy and be greedy when others are fearful”, investors jump into a popular stock in fear that they are, indeed, missing out.
This last one – increasingly referred to as FOMO, i.e. the ‘fear of missing out’ – has become synonymous with retail trading and the social media-led investing trends through 2020 and 2021.
It is an overt feature in the Bitcoin and crypto market and was at the core of the ‘meme-stock’ phenomena in which large groups of Reddit-frequenting smaller investors coordinated to buy up stocks like GameStop, AMC and Blackberry (TSX:BB).
It’s a trend that has been exacerbated during the pandemic, when hordes of newbie retail investors joined the market, often relying on social media for advice.
There’s even an ETF launched earlier this year by Tuttle Capital Management, tracking the most popular stocks as well as special purpose acquisition companies (SPACs), and other ETFs and cryptocurrencies. Perhaps unsurprisingly, its share price has been a rollercoaster since its inception.
Similarly, the VanEck Vectors Social Sentiment ETF, which trading under the ‘BUZZ’ stock market ticker is quite on the nose, focuses on US large-cap equities based on fast-moving social media sentiment.
So, now you know about these common cognitive biases, as an investor what can you do about it?
The first step is accepting that all of us experience them more or less frequently, whether we realise it or not. No one is immune.
Often, figuring out the bias is harder during the decision-making process compared to reflection in hindsight.
“We can only make some modest improvements and not with a high degree of regularity,” Mark Gorzycki, co-founder of investor tool OVTLYR, told Proactive.
“The next best thing is to recognise that they are things that exist in nature that will continue to influence the decisions that others make. And as an investor, that is information that you should put to use to better your position.”
Gorzycki, who may be biased himself as OVTLYR (pronounced ‘outlier’) analyses stocks based on investor behaviour analytics, said that eliminating biases “would be just exceedingly difficult” because it involves rewiring how people think.
While no one will ever make an unbiased decision, there’s hope the FOMO can be noticed before boarding the trendy bandwagon.
Ahead of investing in the stock that that influencer is talking about, do your research, check its fundamentals and make sure its values align with yours.
If the analysis yields disappointing results, try resisting it. If the FOMO is too much and you cave, at least it was an informed decision. Acceptance is always the first step.