Triple-digit percentage single-day swings in stock prices can get your attention. It isn’t all that different from a winning lottery ticket, which also compels a lot of interest.
There’s been more than meets the eye going on with the wild swings in GameStop (GME) and other shares in recent days. In case you’ve missed the news, shares of money-losing video game retailer GameStop have soared 1,700 percent as small investors piled into the stock.
Seen at least in part from interest spurred within a Reddit forum watched by retail (individual) investors, changes in technology and business models (commission-free trades via smartphone) have helped drive access to the stock market. On the face of it, that’s a good thing. Since the lows seen in the stock market early in the pandemic, the ensuing rally has caught most observers off guard. The Federal Reserve’s measures aimed at boosting the economy, including the move to record-low interest rates, have helped boost cash in the system while spurring searches for better returns on investment. It hasn’t been only the stock market attracting this money, as there’s been frenzied interest in cryptocurrency as well.
Questions are also being raised about whether the high degree of speculation could be similar to what was seen two decades ago before the implosion of the dotcom bubble, which cost a lot of investors a lot of money. Others are asking whether this is something for regulators to take a serious look at. The White House said it was “monitoring” the situation. Fed Chairman Jerome Powell, asked about the issue at his Wednesday news conference, said he wouldn’t comment on the performance of an individual stock.
5 questions to ask before chasing individual stocks
Being given the keys to a car is only good if someone knows what they’re doing when they sit behind the wheel, including understanding the risks and the need to have insurance and keeping a seat belt fastened.
“This is tremendously dangerous for retail traders who haven’t traded before,” my Bankrate colleague James Royal told CNBC. “The stock can drop precipitously in a matter of seconds or minutes. If you have no experience dealing with that kind of thing, you will lose your money very, very quickly.”
We don’t advise trading shares of these volatile stocks that have become disconnected from their business fundamentals. That said, if you are asking yourself whether to chase some of these stocks, here are five questions to ask.
1. Can you afford to lose all of the money you put up?
Chasing after high-momentum stocks is only for those who have taken care of other basic financial needs first, including saving for emergencies and retirement. Are all other key financial goals and needs being met? Our Bankrate surveys have traditionally found that the failure to save is the No. 1 financial regret.
2. Are you ready to accept a high degree of volatility with the stock price?
Don’t get onto a roller-coaster ride if you’re easily affected by motion sickness. The same holds true for investors and highly unpredictable stock prices.
3. Do you know what you’re buying?
Most sound investment is done based on fundamental analysis, including an understanding of the company’s business model and profitability outlook.
4. When would you consider selling the stock, or do you want to let it ride indefinitely?
The prospective time horizon and price target are key for understanding when to sell. What happens if the stock posts a decline? Stocks do move both up and down, after all. Would you sell at a loss? At what price?
5. If you sell and make a profit, are you aware of the income tax implications?
When it comes to making a profit in the stock market, there’s no free ride.
My advice: Invest for the long term
Trying to be on the winning end of a highly speculative, or risky, stock investment isn’t my cup of tea. Instead, I offer the same advice I’d give to a friend or family member: Invest for the long term, and save for both the short and long terms.
I don’t disparage anyone else for trying as long as they can afford it, are achieving other financial goals and understand that there’s at least a chance they could lose all of the money they put on the line. If they do come out on the winning side of the stock trade, more power to them. Be aware of the long odds of remaining on the winning end of highly speculative investments over the long term.
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