Lee A. Blackman
Investor Alert: Thinking About Investing in the Latest Hot Stock?
Understand the Significant Risks of Short-Term Trading Based on Social Media
Jan. 29, 2021 The SEC’s Office of Investor Education and Advocacy warns investors of the significant risks of short-term investing based on social media, especially in volatile markets, and provides tips for long-term investing.
Retail investors may seek to profit from volatile markets by buying individual stock, including stock in heavily-promoted companies with smaller market capitalizations. Some of these stocks may be discussed in social media, news aggregators, investment research websites, online investment newsletters, ratings websites, message boards, chat rooms, and discussion forums. It can be tempting to jump on the bandwagon and follow whatever the crowd seems to be doing. Sometimes, however, following the crowd may lead to significant investment losses.
Retail investors should understand that all investments have risk, and that short-term investing in a volatile market carries significant risk of loss.
Short-term trading, including trading aided by the use of margin or options, can lead to significant and unanticipated losses for retail investors. A Library of Congress report identified several investing behaviors that can undermine investment performance, including behaviors that involve short-term investing. Investors should keep in mind these behaviors when considering investing in a volatile market, including:
Investing in Bubbles or Manias. Financial “manias” or a “bubble” is the rapid rise in the price of an investment, reflecting a high degree of collective enthusiasm or exuberance regarding the investment’s prospects. This rapid rise is usually followed by a contraction in the investment’s price. The contraction, or “panic” occurs when there is wide-scale selling of the investment that causes a sharp decline in the investment’s price.
Momentum Investing. Another investing strategy that can pose high risks for retail investors is “momentum investing.” An investor using a momentum investing strategy seeks to capitalize on the continuance of existing trends in the market. A momentum investor believes that large increases in the price of an investment will be followed by additional gains and vice versa for declining values. If that belief turns out to be incorrect, it can lead to significant losses.
Noise Trading. A third related strategy is “noise trading.” Noise trading occurs when an investor makes a decision to buy or sell an investment without the use of fundamental data (that is, economic, financial, and other qualitative or quantitative data that can affect the value of the investment). Noise traders generally have poor timing, follow trends, and overreact to good and bad news in the market.
For more information visit the SEC official website