One really risky strategy that some investors engage in is momentum investing. This strategy is more like gambling with your money more than anything else. It is suited for some traders but it is not really investing in the value investing sense. The problem with this strategy is that many people start to follow the trend without analyzing a company and without determining a company’s real value. When a company gains a lot of buzz many investors fly to make their purchase without checking out what is happening behind the scenes. This is known as speculation. As a result, disaster can happen like when the dotcom era stocks crashed during the tech bubble.
What really happened during the tech bubble that led to the famous dotcom crash?
Well, many investors believed that the internet was going to grow at lighting speed and that it was a source of unlimited profits. During the time many companies went public surrounded by hype and an unhealthy dose of buzz. Stock prices on these companies skyrocketed trading at ridiculous price to earnings ratios. Yet while some investors where making a profit as the prices of their shares climbed the companies themselves weren’t. After a few years a lot of these companies went bankrupt some of them didn’t even have a profitable quarter during their lifespan. When the bubble burst a lot of people lost money. It was all momentum, the mentality was that the price was going up and that you had to buy before it went up even higher, many bought shares and made a quick profit but many lost their entire principal as firms faced mass extinction.
The moral of the story is to learn about a business before investing. If you are new to investing, stick with some blue chips that are reliable and decently priced or invest through a mutual fund that is professionally managed until you get some experience. Another great idea is to buy a few books on investing and perhaps take some basic accounting courses so that you can understand the basics about accounting, financial ratios and financial statements which are the most important tools any investor needs to know how to interpret when making a sell or buy decision. If you have no experience is to consult a financial advisor or a broker and ask him or her to prepare you a diversified investment portfolio that has investments covering different asset classes and sectors like dividend stocks, growth stocks and perhaps some bonds.
At the moment the current speculation and over-optimism trend is shifting towards social sites. Some recent IPOs (initial public offerings) have reached PE ratios (price to earnings ratios) higher than 70 which are extremely high for companies that are sometimes barely making a profit. Would you risk your hard earned savings in such risky bets? This is for you to decide. In my case, I wouldn’t invest a dime in a company that expensive. Besides, the recent correction already hit those stocks really hard leaving a lot of investors bitter.
Photo Credit: renjith krishnan.