Rapidly rising markets can cause long-term investors to abandon their principles and start acting more like gamblers, but Killik & Co’s Tim Bennett think they should “go take a cold shower” if they realise this is happening. 
Recent years have seen a jump in the number of apps allow people to instantly trade markets, but the coronavirus crisis has led to a spike in the number of day traders and speculators looking to capitalise on the rallying shares of the past few months.
Killik & Co head of education Bennett thinks that there are a number of reasons why this is leading to more people acting like gamblers rather than long-term investors. Below, he highlights six reasons why this can happen and how to avoid it in your own portfolio.
The only way is up
Some people start to gamble with the market on the belief that stocks can only rise from here. Bennett identified the rapidly rising markets and volatility as the main factors that have underpinned the “share-buying frenzy” that took hold after the initial coronavirus sell-off and attracted new investors.
“Whilst almost every day we read about how the global economy is in a downward spiral, share prices nonetheless march on,” he said. “In some cases, they are even hitting new record highs if you look at the US technology-heavy Nasdaq index. This has set the scene for a share trading gold rush.”
Everyone is doing it
Humans’ natural survival mechanisms encourage us follow the crowd and leave us prone to the ‘fear of missing out’. However, these instincts – which have been ingrained over tens of thousands of years – rarely help long-term investors.
With the growth in apps that make trading quick and easy, as well as a backdrop of rising equities, playing the stock market has become “the latest crowd craze”, according to Bennett, and these survival mechanisms could be working against investors.
“Over Webex and Zoom, in chat rooms and even in socially distanced bars, you will read about and hear tales of the spectacular gains being made, sometimes in a matter of hours, on individual stocks,” he added.
“And because we only ever hear about the winners in such forums (no-one ever boasts about losses), we are all prone to think: ‘Well, if they are doing it, why can’t I?’.”
We love a good story
Another human trait is the ability to explain the world through an engaging narrative. In the case of coronavirus, the hunt for a cure is a story that everyone is following and this has generated “some truly eye-popping” share price movements.
Bennett highlighted the example of camera firm Eastman Kodak jumped 1,000 per cent in one week in late July when it announced it was looking to produce basic ingredients for drugs, with amateur investors being seen as one of the main drivers of this. The stock has handed back a significant portion of these gains since.
“When we hear tales of such seemingly easy money being made, we are naturally tempted to join in – why wait 20 years to make steady gains when you can double your money in a morning?” he said. “In short, our natural impatience and relatively short attention spans start to get the better of us.”
It’s (too) easy
Bennett pointed out that there are now “countless” ways to bet on shares easily, quickly and cheaply through direct trades, spread bets or CFDs (contracts for difference), often with just a few clicks on a smartphone.
“Whilst this democratisation of investing is welcome in some ways, it is dangerous in others,” he added.
“Too many people are being drawn into what they believe are one-way bets on single stocks, despite all the warnings out there that their capital is at risk and the recent past is no guide to future performance. Whilst shares can offer decent gains on the way up, they can also wipe out 100 per cent of your investment on the way down.”
We crave some fun
It might be no coincidence that the latest surge in investing has come during the coronavirus lockdown, when many people were isolated from their friends and family, left with few leisure outlets outside of work and spending more of their time in front of a screen.
Gambling on shares is pitched as being fun while giving the opportunity to make money – all the added benefit of bringing people together, which is a powerful combination in these unprecedented times.
It won’t happen to me
The final belief that could push some investors to start acting more like gamblers is that they won’t be the ones that are hit with losses if the market does turn. Bennett said this is “packed with danger”.
“Just as studies have revealed that we all rate ourselves above-average drivers, so a part of us may think: ‘Sure, one day this stock will fall rapidly, but I won’t be the one left holding it’,” he explained.
“In short, overconfidence kicks in and we start to lose the ability to disentangle skill and luck when it comes to our share trades. This happens quickest when we make a rapid gain early on. There is nothing like an easy win to feed greed over caution and lead us into taking bigger and bigger risks.”
So how can people start behaving more like a long-term investor than a short-term gambler? Bennett has five tips.
Firstly, have a rational, measured, unemotional and systematic mindset. “If this doesn’t sound like you, then hire someone who fits this description to manage your money for you,” he said.
Next, diversify and never bet on single stocks. Killik reckons most investors need at least 20-25 different stocks to avoid being overly concentrated.
Thirdly, don’t think you can time the market. “Think you can judge the top of the market and sell before then identify the bottom and buy back in? Think you can beat market analysts and veterans at their own game? Turn off your computer immediately and go take a cold shower,” Bennett advised.
Investors also understand that every short-term winner creates a loser. As some as people start think about how to make money overnight from stocks, rather than waiting for long-term compounding to “work its magic”, they are at risk of becoming a gambler.
Finally, investors know to ignore the crowd. “When it comes to investing, stick to your principles and resist the urge to board the next bandwagon,” Bennett finished. “You can stay apart from the day trading crowd by not peering anxiously at stock prices or checking your portfolio value every 10 minutes and not paying attention to every snippet of company news that comes your way.”