Should You Follow the Hype?

Recently there has been an increase in volatile plays in the market with stocks going up 50% in one day as well as 20% down in one day. Aside from this, we’ve also seen a number of parabolic plays which entails straight green candles with the Relative Strength Index (RSI) staying above 70. Naturally, the increase in volatility also causes an increase in “hype”.

Hype refers to the stock recommendations that we see on social media websites as well as from our friends. Despite the negative connotation, hype is not always bad. There are posts that show actual analysis but most of the time, we see posts such as “buy this stock now” without any actual analysis. In the trading community, the term for this type of trading is “Facebook Analysis.” The idea is to go on facebook, look at the posts, and buy stocks without due diligence. This sounds reckless right? That’s because it is.

What can go wrong with Facebook Analysis? On the one hand, you can lose a little bit of money. On the other hand, the worst thing that can happen to you is to profit multiple times through facebook analysis only to lose a lot of money when you oversize your trades because of position sizing. The second scenario is worse because aside from reinforcing bad habits, you will also have the urge to “revenge trade”. Revenge trading is basically taking riskier trades in the hopes of making back your losses. This starts a vicious cycle that is ultimately characteristic of gambling. So what can we do? Should we avoid hyped stocks all together?

Create a Trading Plan

The easiest way to protect yourself from hype is to create a trading plan complete with a trading thesis, entry signals, exit signals, position sizing, and tranching. To clarify some unfamiliar terms, a trading thesis is basically your theory for a stock. Is it a breakout play? Is the stock driven by some catalyst? Whatever it is, the rest of your trading plan should be based on your thesis. Meanwhile, tranching refers to buying (and selling) the stock multiple times as opposed to buying (and selling) your shares all at once. This might reduce the potential upside from a stock, but it also protects you from unexpected market activity. At the end of the day, there is nothing wrong with reading hype posts as long as you make your own objective analysis of the stock.

Listen to the Market

There might be some of you thinking that hyped stocks aren’t worth the risk. The reality is, you should not ignore hype posts because in order to be profitable, you need to follow the big money. The “big money” includes institutional traders that basically run the market. These institutional traders do not trade all types of stocks at once. Instead, they put their money in specific sectors such as mining, telcos, and services. This is where the expression “a rising tide lifts all boats” comes from. If one stock goes up 30%, stocks in the same sector will most likely rise up as well. If you miss out on the big market moves, chances are, you won’t be able to beat the market.

Conclusion
Taking advantage of hyped stocks all comes down to doing your analysis. No matter how many recommendations you see about a stock, you should never buy the stock right away, but at the same time, you also shouldn’t dismiss hyped stocks right away. Always remember to follow the big money but do your own analysis. Hopefully, through this article, you will never buy (and dismiss) a hyped stock right away.