This Is What Can Go Wrong When You Buy Into A “Trending” Stock

Have you ever lost money because you bought into an investment that you didn't quite understand?

Be it an investment-linked plan (read why I cancelled mine here), a stock you didn't understand or even in complex stock market instruments (read how Australian retail investors lost over $400 million in a single week on CFDs here)?

There has been a lot of flurry in the investment markets over the past few months, no thanks in part to the combination of COVID-19's impact on the economy and that of oil prices crashing. And in the midst of that all, several stocks have been in the spotlight - Singapore Airlines, Sheng Siong, Biolidics, Zoom Video Communications, Tesla...just to name a few.

But before you jump in and buy the next “hot stock” that has been trending online, I wanted to emphasise a really important point:

The most important rule in investing is to invest in what you understand

The more you don't understand, the more likely you are to lose money in the stock markets.

And just because something is trending, doesn't necessarily mean it is necessarily a good investment.

In the last few weeks, I've been appalled by some of the comments I've been seeing on several investment groups on social media, where folks admitted that they invested into SIA stocks largely based on a singular premise: because they thought the government was going to bail them out for sure.

That's...hardly enough. And today, some of these investors are crying foul over the recently announced rights issue, as well as the oil hedging losses that SIA has now been hit with. If you had invested into SIA then as well, were you familiar with how SIA’s business works? Did you know about the risks surrounding their business with oil hedging contracts, and the fixed costs they would have to incur now and over the near future as global travel comes to a halt?

If you didn’t, then you can hardly blame anyone but yourself for the losses you’ve incurred on this investment.

Or how about the oil investors (or perhaps “speculators” will be a better word) who bought into oil futures when oil prices crashed, without expecting that it could possibly enter negative territory? Many of these folks have been wiped out and had margin calls on their account, losses that some of them might not even be able to repay to their brokerages.

If you think that can’t happen to you, think again.

Some of you might be wondering, what could possibly go wrong when you buy into a trending stock?

Plenty. Aside from the obvious fact that you’re going in blind when you invest in something you hardly understand, you will also never know the real reason why a stock is trending.

You see, the Internet is full of shady pump-and-dump schemes and misinformation. You can lose a lot of money when you invest because of these.

Another concern is whether you might already be too late to the game. Stock prices are usually forward-looking, and some companies may now be overvalued if all of its potential has already been priced in by the markets.

How do you know if it is overvalued? Well, for starters, you need to know how to calculate that what the business is worth. While there are many strategies that you can use (eg. the discounted cash flow model, net asset value, price-to-book ratio, price-to-earnings, price-to-sales, etc), you need to know when to use which strategy for what stock.

So if you invested in a trending stock for no other reason than the fact that you heard about it from your friends (or online), then be prepared to lose money, because that’s what happens most of the time. We've to take responsibility for our own mistakes, and that of our own losses.

At the end of the day, you should really only invest in (stocks of) businesses that you understand, and not based on what's trending.

The bottomline is, if you don't understand it, then don't buy it.

There's no doubt that the recent stock market crash has unveiled a lot of good opportunities. But there are also bad eggs and value traps.

Just don't get caught in the wrong ones.

In these unprecedented times, it is worth remembering the most important rules in investing once more. Find out what they are in the video below:

This article is by Budget Babe – Singapore's top female personal finance and lifestyle blogger. As featured by many government statutory boards as well as The Straits Times, Channel News Asia, Mothership.sg, AsiaOne, Lianhe Wanbao, Her World, Cleo, The Singapore Women's Weekly, CPF Board, 938 Live, MoneyFM and more. With over 7 million readers in just 4 years alone and with 12,000 daily subscribers, Budget Babe is Singapore's leading financial talent.

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