Why Retail Investors Keep Chasing Momentum, And Paying The Price

By Piyush Khatri, SEBI RIA

In financial markets, popularity often arrives late. When an asset gains widespread attention, a significant portion of the rally typically precedes it. Yet this stage is often when retail investors begin paying attention. Rising prices create excitement; excitement brings in new buyers, and that additional capital pushes prices even higher, at least for a while. When the momentum wanes, many late entrants find themselves holding losses. Silver serves as a prime example. At the beginning of one of its rallies, silver started rising steadily in price, yet no one seemed to be paying much attention.

Of course, when the rally continued, and silver’s price rose several times over, a different story began unfolding. Silver started making headlines in conversations on social media platforms and brokerage firm commentary. Investors who had ignored silver’s run in the past now saw it as a trend they did not want to be left out of.

That fear of missing out, or FOMO, pushed many to buy after most of the rally had already occurred. When prices later corrected and the momentum cooled, those who entered late found themselves holding positions at much higher levels. This phenomenon isn't confined to commodities, either. Equity markets have shown a similar cycle time again and again. The meme stock frenzy of 2021, the trend that captured so much attention, serves as a prime example of this worldwide phenomenon. The stock has been operating at relatively lower prices before it underwent a remarkable rally, largely fueled by online communities and strong retail investor interest in the stock. As social media buzz around the stock intensified, more investors rushed in, significantly boosting both its price and trading volume.

For some time, it seemed like there was no stopping the rally in the company’s stock. However, once the excitement died down, the stock price retraced considerably.

To some extent, something similar to this was also witnessed in the case of a prominent electric vehicle manufacturer’s stock. Investors who invested in the company’s shares at relatively earlier periods, when there was still some conviction in the company’s long-term vision, made remarkable profits from their investments in the stock. However, as the company’s stock prices rose considerably, making it one of the most sought-after stocks in the market, more and more investors were attracted to it, driven by its relatively high stock prices.

Closer to home, similar patterns were visible in certain highly leveraged conglomerate-linked stocks during periods of strong price momentum. As these stocks continued rising, trading activity increased dramatically. A lot of retail investors jumped in, lured by the quick price gains, rather than any real understanding of the underlying value. As the story shifted and the market became more unstable, those who came in late saw their investments take a serious hit.

The frequency of this behaviour is a complex phenomenon. Its sustained presence is determined by psychological, environmental and biological factors. Understanding the underlying framework is essential for tackling the issue effectively, which is rooted in human psychology. Investors feel comfortable buying something that is already rising because it appears safe. A rising price creates an illusion of certainty. When everyone around you is talking about an asset making money, it feels rational to participate. In reality, markets reward early conviction far more than late enthusiasm.

Momentum also generates social proof. Investors observe increased trading volumes and news headlines about all-time highs, which leads them to conclude that the majority of investors are aware of something that they are not. This results in herd behaviour, where investors tend to follow the majority of investors rather than conducting their own analysis.

Another factor at play is the concept of recency bias, where investors are convinced that what has been happening recently will continue happening forever. For instance, if silver prices have doubled or tripled over the last few months, people are likely to think that this trend of rising prices will continue at the same rate. However, this is not always the case, as financial markets are cyclical in nature.

In terms of the structure of the financial market, the rising prices create a situation where investors are convinced that, because of the rising prices, this is a good time to buy, not realising that this might be the peak of speculation in the prices.

Ironically, the best opportunities are usually available at a time when there is little excitement in the market. Assets that are undervalued or overlooked are usually better opportunities, but investing in those opportunities requires patience, research, and a willingness to invest at a time when others are not.

Most retail investors do the opposite of what they should do. They ignore an asset when it is undervalued, but they buy into an asset when it becomes overvalued. The lesson in the silver trade, the momentum stocks, and all the other cycles in the markets is simple. One should not invest in the markets based on price movements. Indeed, by the time the markets are going up and the excitement is high, the best opportunities have already been taken.

The secret to successful investing is discipline – going in early based on research, staying in through the volatility, and coming out when the valuations are high, not when the excitement is high. In the markets, there are many stories based on momentum. But the truth is, wealth is created through discipline.

(The author is Principal Officer and Managing Director of Sahastha Investment Advisers Private Limited)

(Disclaimer: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.)