The Fear of Missing Out, or FOMO, is a psychological mind game that can trap even the most experienced investors in unfavorable trades.
Investors should always be wary of FOMO-driven trades and should practice actively rationalizing why it is that they want to own a particular stock in the first place.
FOMO and Investing:
The fear of missing out is a driving force behind a lot of our best and most memorable nights socially, especially those we did not plan to happen. However, when applied to investing, this same fear can drive a lot of the worst and most regrettable trades that an investor will make.
FOMO investing is driven by the deadly sin of envy. Investors experience this when they see a massive swing in the price of a stock and begin to feel jealous of those who were lucky enough to experience full price swing. This causes investors to act rashly and try to join the fun, without having done their normal due diligence. The investor has then bought into a trade that they wouldn’t have necessarily have made otherwise. What’s even worse is they likely bought in nearer the end of the rally than the beginning, meaning they more likely bought into the subsequent downswing, as opposed to a continuing rally.
FOMO investments go against the most basic and well-known investing mantra that exists: buy low, sell high. FOMO trades go against this saying because steep losses tend to follow shortly behind significant price increases. The investor assumes in this case that events that have occurred, will continue to occur, and often is burdened with losses because of it.
Tips to Avoid FOMO:
Hindsight or Eyesight - One easy way to know if you are making a trade out of FOMO is by asking yourself the question, "Is it hindsight or eyesight?"
Am I considering this stock because of how it moved or is it because I see something attractive in the company’s chart, EBITDA, future cash flows, earnings, or something else?
If the trade is purely from a hindsight related realization, i.e. the stock is up sharply recently, then the trade is almost certainly a FOMO trade that should be avoided like the plague, or the 'rona. This is simple enough in theory, however, the allure of quick, easy, and seemingly guaranteed gains can be enough to pull even the most experienced of investors to join a trade they regret.
This gets more difficult, however, when the stock experiencing the price swing is one that you have been monitoring, but not bought into yet. These can be the most difficult FOMO trades to avoid due to an overconfidence that develops as the investor watches a stock they've studied soar without them. The investor can see this as something that they saw coming and become overconfident in the stock, and their ability to predict its movements, leading them to falsely assume a continuation of the current rally.
In these circumstances, investors should reassess the stock to see if the price is still below what they believe it is worth, while trying to ignore the massive swing. If the investor can successfully ignore today’s price movement, they should be able to tell if they want to buy because the stock is still attractively priced or if it was attractive at yesterday’s price with the knowledge of what today would bring.
Explain the Trade - Another great way to decipher if a trade is the result of FOMO is to try explaining the reasoning behind the trade, out loud, to a friend, colleague, or even yourself.
When explaining the trade, do you find yourself ranting or raving about how great the company is, how their profit margins are increasing every year, how they just smashed earnings, and why you follow their CEO on Twitter? If so, then you probably really believe in this company and they could still be a good buy. That doesn’t mean, however, that purchasing the stock in the morning to sell in the afternoon is a good option.
If you are in this position, it is extremely important to recognize the fact that no matter what, you likely missed most of the intra-day hype surrounding the stock. That means being mature and recognizing that more likely than not, the day trade option on the stock has passed. This investor should know and accept that you can't win every battle and look for better opportunities elsewhere. Missing a rally does not mean that the stock has no place in your portfolio, but rather that its place has shifted from a shorter holding to a longer one.