Seeing a particular stock or investment opportunity skyrocket can trigger a desire to get in on the action. Here’s an example of what you’re up against, and why having a fundamental thesis matters.
During my time as an institutional investor, I sat through a slew of hot opportunities, many of which we let pass us by. If we couldn’t understand why a company or opportunity was fundamentally going to grow well, we’d let it go. Fortunately we caught our fair share of excellent opportunities, but there was certainly a list we maintained of our “biggest misses.”
You probably have a list of your own. It’s natural to kick yourself in hindsight for not jumping on a bandwagon once you see how well others have done, like buying Amazon or Apple back in their early days. I always like to keep in mind, though, how important it is to stick to investing in opportunities I understand and have a real thesis for, and I’d like to share an example of why.
The opportunities we are tempted to pursue without proper research tend to be momentum-based stories. You see a company or asset in the news every week growing 5%, 10%, 15% or more. Your uncle just made $100,000 in a month betting on the story. Your beer buddy just took out a loan to invest some money in opportunity X and has already made all his money back and more.
Momentum investing – buying high and selling higher – is a legitimate strategy. But it still requires a thesis for why you think the opportunity will continue to grow. It’s tempting to see momentum and just think “if it’s growing, it’ll continue to grow for at least a little longer,” but that justification could leave you open to a lot of heartache. Here’s a great example from the cryptocurrency craze of what you’re actually up against, and why blindly using existing momentum as a reason to invest can get you in trouble.
Cryptocurrency Pump And Dump Groups
You have probably seen at least a dozen headlines about XYZ cryptocurrency doubling overnight. First it was Bitcoin. Then Ethereum. The most hilarious one to me was Doge Coin, a cryptocurrency with the Shiba Inu as its mascot which was created as a total joke by its founder, which recently surpassed a billion dollars in value. This has led thousands of retail investors to get into cryptocurrency trading. They try and find the next big cryptocurrency, invest, and hopefully ride away into the sunset with their millions.
A lot of retail investors, though, are just watching for news of early growth movement and piling on with little diligence as to what makes that new cryptocurrency special. And groups have formed to take advantage of their ignorance.
Source: The Outline
The Outline had a reporter join and interact with 12 groups formed to perform so-called pump and dump operations. Here’s how one of these groups describes the mission to its 30,000+ members:
The Alt Pump: “Pumping is the process through which a large group of people agree to buy a certain coin at a particular time….With this group, you will have large amounts of people buying a coin at the same time. This will pump the price straight up. After this the dumping part comes in. After the price rises tremendously up because of the pumping, we start selling at a good profit. This is called dumping.”
What does this look like in practice? Here’s a price chart of GVT, a cryptocurrency that was a recent target of one of these pump and dump groups.
Source: The Outline
From the time before the pump signal to the peak, the price moved 55% due to the scheme. Imagine being a retail investor on the outside seeing this kind of momentum. You might very well end up being the schmuck buying shares from a pumper, thinking you were getting in on the next big thing while they ran off scot free with with your money.
The pump and dump groups as they are currently managed are fairly clumsy. Managing that many investors is challenging and there isn’t a controlled selling off that enables them to keep the prices at the higher levels for a more stable time period and enable them to cash out more total profits. This type of market-moving scheme is not limited to retail investors, though. It can and has been used by operations with millions at their disposal who can target an individual stock with low trading volume.
As a single party with deep pockets, they can affect the price for a more prolonged period with more fine-tuned control. You won’t find this kind of chicanery in large, high-volume stocks like Apple because there are few folks with deep enough pockets to affect them, but it certainly can and does happen in more mainstream investments like individual stocks, not just cryptocurrency.
The whole article is worth a read if you want to check it out over here.
If you’re interested in making individualized bets, it’s important to have a fundamental thesis for why something is expected to grow and in what time frame. This will do a lot to insulate you from attacks like the above. Avoid the temptation to buy into something just because “it’s climbing so fast.” You can certainly use its momentum to trigger your research, but you should develop a thesis as to why you’re excited about the opportunity that extends beyond its short-term price performance.
Better Ways To Invest
If you’re looking for examples of what thesis-based investing looks like, below are a few articles from the archives. I make no representation as to whether they’re particularly good theses (that gets proven out over the next few years as we see how the investment plays out), but you can get ideas of how to construct and test your own ideas.
- Index Funds: How To Generate 8-10% Returns
- How To Evaluate Your Home As An Investment
- Breaking Down My Latest Stock Buying Decision: BAC-L
- Where To Put Your Next $100K: Investing In Today’s Environment
Looking For a Brokerage Provider? Want to Track Your Investments Better?
If you’re looking for a brokerage firm, the one that has the bulk of my money is TD Ameritrade. TD Ameritrade was the first brokerage firm I opened an account with, and it is still my favorite because of its customer service, UI, and low commissions. I now have several brokerage accounts just to take advantage of SIPC protections, but TD Ameritrade is the one I recommend you get started with if you’re looking for something.
You can check it out here. And bonus: I know they’re currently running a sign-up bonus which includes free trades and up to $600+ depending on how much you’re putting in the brokerage account.
Tracking Your Investments
If you want a great way to track your investments, I like and use Personal Capital. They offer a free net worth and expense tracker. The neat thing they do is provide benchmarks of how your portfolio is doing against best practices, and they also include some pretty strong tools for planning your retirement (I like their retirement calculator) as well as for saving for certain medium-term goals.
Had you heard of pump and dump schemes before? What do you think of blind momentum investing?