It’s the situation that every investor dreams of. You buy a stock, and within days it’s almost doubled in value.
Well, that’s what happened to a stock I discussed here in The Right Side last week. I should be elated. But I’m not. Why?
If you remember, last week I showed you how you can get in on what’s likely to be the world’s largest find of lithium, a metal in booming demand, and an investment barely anyone knows about.
Now, anyone who took me up on that idea is in the money. I suggested Rare Earth Minerals (REM) when its stock was trading at less than half a penny. Fast forward a week and it’s nudging 0.9p. That’s nearly a 100% gain in just a week.
But I’ve got a funny feeling about this. How can a share like REM near on double in days, even though there’s been little change in the underlying investment case? Well, I’ve got a theory.
It’s the good old investor bandwagon
Just so we’re clear, when it comes to speculative investments, this sort of price movement is by no means unusual. Illiquid shares that suddenly see a bit of investor interest can end up in very limited supply. That’s when the share price takes off.
But I don’t think that the fact that this is an illiquid market explains this jump. I think there’s a bit of investor psychology involved here, and it’s this psychology that I want to look at today.
I want to show you how understanding the psychology of markets can keep you from getting skinned.
Think about this: we now know that around 95% of our decision-making process isn’t controlled by our conscious mind. Instead, it’s driven by our deeply-entrenched animal instincts.
That can be a difficult pill to swallow. The belief that you’ve carefully selected an investment based on an objective assessment of its pros and cons is unfortunately only a fraction of the truth.
For investors, this leaves little thoughts lingering in the mind. You might know them. “You’ve seen these sorts of stocks fly before… You missed your chance last time and you’ve lived to regret it… Get in before it’s too late!”
In some situations, it’s all about greed. In other situations, it’s fear.
That’s how investor bandwagons get rolling. But to be successful, you need to control these animal instincts. You need to make sure they don’t leave you open to exploitation by others in the market.
Don’t fall prey to the pros
Make no mistake – the subconscious is an absolute devil when it comes to dealing in capital markets. Far from being your friend, you need to fight it. That’s because in the market, other players are just sitting there, ready to jump on and exploit any and all errors they can.
Think about it this way. As soon as there are buyers clamouring for a stock, for whatever reason, the stock price will go up.
Market makers and speculators follow the news stories too. They know what stocks are hot, and they know how people think. So, the minute they smell blood, they will move the price up in anticipation of unwary prey. They know exactly how the very act of pushing the price up actually draws in more punters keen to get in on a rising stock.
And beware, dear reader. I fear that this is precisely what’s going on with REM just now.
Something is up here
Let’s be clear – I believe in the business that underlies this stock. In many ways I can see this being what traders call a multi-bagger – an investment that goes up by multiple times its buy price.
But there is something just fundamentally wrong with the share price action we’ve seen in REM over the last week. There’s more than a whiff of exploitation in the air right now.
As a result, I suspect that once the new hot money subsides, the shares will fall back somewhat.
Here’s my prediction: REM will find a new level; probably higher than before the recent furore, but lower than today.
But given the exciting opportunity here, I also suspect that the shares will build a base, from where they can once again move forward. If you are in, then well done you. I think we’ve got a very decent speculative punt for the medium to long term.
If you’re not in yet, then now is not the time. Sit tight and wait for the commotion to subside.
Whether you’re a spectator or a participant, whatever happens this is going to be quite a ride. I’ll be updating the situation as things move along, but this is a timely reminder to keep your wits about you in the market.