Investor Stampedes and Stock Market Manias

Stock market manias can be costly.

People Rushing in a crowd
Crowd of People Running. CSA Images/Snapstock

Stampede investing is kind of the "dirty little secret" of the stock market. That is because, by the very nature of the mania, almost all of us get involved (and by extension, almost all of us lose).

These buying stampedes probably seem like a brilliant idea at the time, not because the investor mania itself has any value, but because the underlying business idea is usually ground-breaking, brilliant, and game-changing.

However, all of these crowd-based activities just keep ending up the same way - with massive, quick losses for nearly everyone involved. The shame (which is often worse than the actual financial losses) is usually embarrassing enough that the victims are fine with hiding their mistake or quickly changing the subject. ( The author was the same, back when he got started).

In fact, they typically swear that they were foolish to get worked up by the crowd, and/or the latest social trend. They swear they will never fall for another stampede again. And then they do...

Over many years, there has been the Dot Com bubble, the Iraqi Dinar scam, the "Pot Penny Stock Frenzy," the California Gold Rush, the Dutch Tulip Bulb Mania, the more recent solar panel company stampede or even the Green Energy Revolution just to name a few.

The point isn't that there is anything inherently wrong with the underlying business concept - we do need solar panels and 3D printing and legalized recreational marijuana and green energy.

The issue is that the masses lock onto a great idea, and think that the concept alone should make investing in related companies both smart, and profitable.

The automobile is a wonderful concept. We still use them to this day, they eradicated the horse-drawn carriage, and the main corporations sell millions of vehicles each year.

So, was it a good idea to invest in them? Absolutely, unconditionally not.

Around the year 1900, there were about 1,800 automobile manufacturers based in America. How many of them still exist? How many investor dollars were obliterated?

The answer to that last question is 99.98%.

When everyone is buying the same thing at once, the underlying investment is typically overvalued. At the same time, new companies are getting into the space at a furious, absolutely unsustainable pace.

The share prices get dramatically and ridiculously too high, while new investors keep plowing into the stocks and sending the investment into the stratosphere.

Why else would a small mom & pop marijuana store be valued on the stock market at nearly half a billion dollars? Why else would someone trade their entire house for a single tulip bulb? Why else give up your entire life, to race across the country and pan in the rivers for gold?

The manias and stampedes of investors is a pivotal, incredibly important concept in people's psychology. That is precisely why so much of the brand new content in the revised edition of, "Penny Stocks for Dummies" is dedicated to precisely this concept.

With investing, it sometimes pays to stay with the crowd.

However, it is usually a better idea to go against the masses, especially when those masses are all doing the exact same thing.

The conversation here is not about investor manias. It is about human psychology. No one wants to "miss the boat," while everyone else is cashing in. If given the choice, no one would decide to sit on the sidelines, while their friends and neighbors look smart and get rich easily.

There is also the factor of trust. People trust the media, so if they are seeing stories about the latest hot topic on the news, they believe that this is an affirmation of the significance of the underlying idea. In reality, it is not a guideline to get involved, it is just a news story - a small snippet of coverage on the topic which is on the tip of everyone's tongue as of late.

There is also the effect of individuals trusting themselves.

They think that proper due diligence involves simple logic (well, people gotta eat, so restaurants are great investments), or knowing that the underlying concept or topic is exceedingly popular right now (on the news, or in conversations with their friends).

When someone comes to an advisor to ask about buying the latest hot topic stock, they should ask them a few questions. Who is the CEO? Where did she or he work previously? What are their sales levels? How much growth do they expect next year? How will the achieve that growth?

Guess what their answers are? If you said anything other than, "beats me," then you missed the point.

Oddly (and a sure sign that society is right in the heat of a major stock market mania), even after spectacularly failing the simple question test, they follow up with, "so, should I buy?"

They don't want to be exposed to the light of proper due diligence. They would rather have the blessing of their advisor to jump into the stampede, although why should they need it?

Another sure sign of a mania is when your grandma or distant second cousin phones you up, to tell you about some hot Internet company. Or your New York cabbie tells you about some investment which he is excited to tell you is going to explode in price.

Even more telling is when people come to me to ask about a specific penny stock... which is the exact same company two people asked me about the day before, and which another person will ask about tomorrow.

Many tiny investments, especially penny stocks, will indeed multiply in value many times over... at first at least. Then they crash back down, without warning or mercy.

The thing about a buying stampede is that by the time the majority hear about it for the very first time, the upward drive is either leveling off or about to crash. By the very nature of mass-market actions, the rise of any stock is a factor of the percentage of people buying. Therefore, the most people know about something right as the buying demand peaks.

The situation is unfortunate. Worse, it is common.

Do not trick yourself into thinking that stock market stampedes are confined to the examples we've provided above. That merely represents some of the more interesting, or historically relevant, events.

In actuality, there are several investors manias going on all around you right now, and several more big ones on their way, which we have not yet even begun to comprehend. Consider the push towards electric cars (which has lifted the value of the tiny Tesla company as high as that of the much-larger General Motors).  Or, what about the Uber taxi-on-demand system, which again is a great idea, but may not necessarily make a great investment.

Most investors fuel these manias because they want a piece of the pie like everyone else seems to be getting. They are quick to jump onto whatever concept is "hot," "ground-breaking," "will disrupt social norms..."

Well, this would all be fine and good, if it were not for the downside. Unfortunately, and stampedes and manias always end the same way. Guess what the final chapter looks like.