How ‘FOMO’ Can Drive Momentum Market Trading
Opinion

How ‘FOMO’ Can Drive Momentum Market Trading

Call it status anxiety, call it greed or just call it clever momentum trading, but the ‘fear of missing out’ is an under-appreciated force in financial markets.

No one likes to miss out on a good thing, especially when they see their friends, neighbors and rivals cashing in, a phenomenon three-card-monte dealers have long understood.

There are (at least) two markets right now which show meaningful signs of attracting capital in substantial part because of this fear: China’s stock market and Silicon Valley’s unicorn factory.

In China, which is enjoying a vertiginous market ride upwards, money is flowing into stocks in part because investors believe the authorities 'want' a bull market and in part because of media and social media attention fanning the flames.

Related: Why China’s Stock Bubble Isn’t Ready to Burst

Bill Janeway, a veteran venture capitalist, sees fear of missing out, or FOMO, as part of the motive force behind the rush of private capital into early-stage and more mature but often still unprofitable tech companies. “We are in an environment of extraordinary low interest rates, of enormous quantities of liquidity looking for a return,” Janeway said in a podcast interview with venture capital company Andreessen Horowitz. 

“There is the phenomenon of FOMO, fear of missing out on the next Facebook, the next Twitter.”

Venture capitalists are so motivated by the prospect of huge scores if they identify the next social media or other giant that they are funding non-public companies in unprecedented sizes. That’s allowed the advent of Unicorns, the 90 or so companies with market values of $1 billion or more, which have been entirely funded on the private markets.

Janeway sees reason as well as fear behind the behavior, with investors taking multiple bets, each with a relatively low probability of success, but hoping for outsize returns from the very few which do succeed. Which is different of course from saying that the mass of funds put into these companies will collectively earn a respectable return.

In China, the more than doubling in the Shanghai stock exchange has attracted legions of new investors. Shanghai stocks fell 6.5 percent on Thursday, however, and ended Friday little changed after an early 4 percent drop.

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New equity trading accounts rose 433 percent in the first quarter from a year earlier, according to official data, with more than half the accounts set up by investors aged up to their early 30s. The China Household Finance Survey found that more than two thirds of the new investors in equities had not completed high school. 

FOMO

Much of this may be driven by concerns about relative wealth, or how much you have compared to those in your group, a force explored in a 2007 paper by Peter DeMarzo and Ilan Kramer of Stanford University and Ron Kaniel of Duke University. 

They found that even when traders understand that prices are too high they may stay in the market because they fear losing out as the overvaluation persists and extends. “Relative wealth concerns help support the existence of financial bubbles by increasing the risk of trading against the crowd,” the study found. “When relative wealth concerns are sufficiently strong, they can promote the creation of price bubbles.” 

Investors want to keep pace with their peers, and fear not having as much wealth. That raises, in a certain way, the risk of selling into a bubble. That status and group-motivated anxiety can blind investors toward other, seemingly obvious risks. 

Related: Guess What Stock Has Run Up 89 Percent in the Last Year

In some ways, this seems to be more likely to happen in microclimates like Silicon Valley than in a large economy like China. After all, the huge influx of wealth has driven up the cost of most things people would like to buy, like houses, in Silicon Valley, while at the same time recalibrating upwards expectations about what constitutes an acceptable standard of living. 

That is perhaps less true in China where the amount of wealth being generated is far smaller in relation to the economy. This is true, so far as it goes, but investors often get their expectations and sense of what is normal from communities, online or in real life. In these communities, tall, or true, tales of gains serve to drive further investors into risky assets and to make them less sensitive to risks.

Janeway makes a larger point: that often these types of bubbles produce transformative technologies that otherwise would not come into being as quickly. Just as people lost money in railroad shares in the 19th century, or radio stocks in the 1920s, so did the railroad and radio transform modern life.

“The way to think about financial speculation is that bubbles are banal but every once in a while they are necessary.”

A better strategy might be to put aside fear of being left behind and enjoy the changes the bubbles finance.

(At the time of publication, James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

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