How to avoid getting caught in investor hype? Here are 5 ways to differentiate FOMO from long-term growth

Getting caught in investor hype is not the only trap investors can get caught into, but it is one of the biggest that retail investors can get into as well.

Look no further than the queues to buy gold at bullion stores all over Australia earlier in October. How many of those investors are now underwater? We’d suspect some are. Yes, some may have been planning to hold for the long-term and may ultimately come out ahead, but we think it wouldn’t be unreasonable to suspect some thought they’d make 50% in a month, like those who bought in late August did.

We know we cannot stop all investors making the same mistake. But we hope in writing this article, we hope we can stop some investors from doing so.

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5 red flags investors should look for to avoid getting caught in investor hype

1. No one is talking about downside risks

When gold was going up and up, was anyone talking about downside risks? No. It would not have been unreasonable to speculate that things could happen like central banks u-turning and selling gold rather than buying, plus the US dollar remaining strong. When Beyond Meat was surging earlier this month, all the factors why it was sold down for so long were forgotten (at least by those buying).

The key for investors is to ask themselves about possible downside risks and observe whether or not anyone else is talking about them. If not, then rallies are likely driven by FOMO rather than anything else.

2. Large TAMs

Here’s a good rule of thumb. If a company is capitalised below A$500m and is talking about a TAM of >$10bn, then it is hype. Now, a company may go big and crack some of the market, but just talking about a large TAM could be a big red flag. Xero, a company capped at $25bn, may have the right to talk about having a $100bn TAM, but any smaller companies talking about that would be purely trying to get investors to buy out of FOMO.

The companies that have grown to become large (i.e. Uber and Meta) all started on a smaller scale and had no ambitions to go worldwide. Meta was only intended to connect Harvard in Zuckerberg’s days on campus, and Uber was intended to be a limousine service for executives. From little things, big things grow – that is true. But if you’ve got a penny stock talking about a TAM of >$10bn, how are they more credible than Aerotyne International?

3. Having no plan to fund growth ambitions

Often, investors are lured to companies by the promise of growing big. But they often neglect to ask themselves how it will be achieved? Not just from a marketing and product differentiation standpoint, but financial too? Will they be able to use reinvested profits to grow? Will they be able to rely on debt and equity finance, and if so, to what extent? Will they even be able to raise debt and equity finance to the point of being self-sustainable.

Also, ask how long the growth ambitions will take and are any timelines realistic? We all want to make money as fast as possible, but it can take time. And patience can sometimes pay off. Buying the hype rarely ends well, and in the rare instances it does, it is when the timing is absolutely perfect.

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4. One-sided trading momentum

We are big fans of the RSI (Relative Strength Index). It is a number between 0 and 100 that looks at buying v selling momentum. As a general rule of thumb, anything over 70 is overbought and theoretically will correct itself in due course. If a company’s RSI is over 70, ask yourself why it is overbought. Is it genuinely succeeding or is it just investors being lured into the hype by the prospect of success.

5. Being a small fish in a crowded pond

So often, companies try to sell themselves to investors by saying they’ll crack a lucrative market, but by being different and investors buy the hype. Case in point: Many BNPL wannabes like Zebit, Openpay and Payright lured investors by saying they were different – in one way or another.

For instance, some said they were for larger purchases and could be used as budgeting tools rather than for binge-spending on goods consumers really did not need (if they did, they’d use their own money). And investors who missed out on Afterpay had FOMO (or FOMOA – fear of missing out again).

The question to ask in those scenarios is, are these players really different (other than name and branding)? Of course, explicit comparisons to big players can be problematic too. For instance, if they had come out and said ‘We’re going to be the next Afterpay’, that would’ve been equally problematic.

Of course, some of the most successful businesses have been ‘second movers’, just Ask Jeeves, which was overtaken by Google. But Google overtook it because it was superior, it gave a plelethora of results and had a catchy name too. And ironically now, Google is threatened by ChatGPT because ChatGPT gives even better results. But of course, ChatGPT would’ve been nothing had it not had a product better than Google.