What is FOMO and how to detect it

In finances, there is a certain type of behaviour called panic buying. What usually precedes it is a hasty increase in purchase volume. This will typically result in the price of a good or security increasing accordingly. From a large-scale perspective, panic buying cuts down on supply and creates higher demand. This effectively leads to much higher inflation in price. Conversely, on a micro-level (like in investment markets), there is FOMO or buying thanks to a short squeeze. Both of these can provoke panic buying.

FOMO is what we will be focusing on. It is a concept that ties into market preparation because try as we might, we cannot predict everything. There are certain moves that no one is able to foresee. Most of the time, real-time reactions are a necessity for these moves. While day traders with experience may possess the agility to conquer these trades, beginner traders can be overwhelmed. They constantly ask themselves if they should enter it or avoid it. Moreover, they worry that they will miss out on a potentially huge move.

This is where FOMO comes in because it is an acronym for that particular worry.

What does it mean?

FOMO stands for ‘fear of missing out’. It is a recurring enemy for all traders and influences the decision-making abilities of traders on multiple levels. Frequently experiencing FOMO is not uncommon; every investor will feel it at some point.

A conventional FOMO trade is basically a trade you make strictly out of fear of missing the move. When a stock goes through abrupt volatility, some traders may become incredibly anxious. In a way, you will feel as though you have an opportunity that will not present itself a second time. Obviously, you do not want to miss out on the move. Stemming from such high volatility, you have no choice but to make a fast decision on either entering or avoiding.

FOMO is arguably the leading cause of poor decisions in both trading and investments. Overall, it is such an overpowering sensation that results in us making bad decisions with our money. If you want to make the best capital decisions, then you will have to learn how to properly handle FOMO. The best traders in the field have successful strategies that help combat FOMO.

The driving force

There are a variety of causes for FOMO. Some are more intricate than others, but the ones below are among the most common.

  1. Exceptionally high expectations – This is essentially when you are under the impression that you have to double your account by the following month. Moreover, that you are automatically missing out if you do not make a profit as soon as possible. This inevitably leads to higher risk and considerably large position sizes
  2. Impatience – In which you do not want to wait around for the setup. More than anything, you want to get into a trade out of a fear that the price could run away.
  3. No long-lasting perspective – When you do not fully grasp the fact that there will be a lot of new trades waiting for you. A majority of amateurs tend to place too much importance on one trade. Furthermore, they want to force this trade to win, regardless of what it will take.
  4. A lack of rules – This is when you do not have rules or a system set in stone, so FOMO is your default mode. In other words, constantly jumping in and out of the market without understanding what exactly you are doing.
  5. Little to no confidence – Following some losing trades, most traders will attempt to catch up. They will enter random trades just so to gain access to the market. By doing this, they hope to generate a substantial profit.
  6. Overconfidence – In which you come off of a winning streak and you are feeling invincible. As a result, you ride the proverbial high and take random trades or too large positions. You are of the belief that you are able to “feel” what is going to happen in the market.

Why does this kind of trading happen?

While the above six reasons are indeed common, the primary cause of FOMO is a unique phenomenon. This anomaly goes by the name of ‘hindsight bias’. This is a psychology term that describes:

“…the tendency of people to overestimate their ability to have predicted an outcome that could not possibly have been predicted. In essence, the hindsight bias is sort of like saying ‘I knew it!’ when an outcome (either expected or unexpected) occurs – and the belief that one actually predicted it correctly.”

FOMO proves itself to be prevalent primarily in small-cap traders. This is because small-cap stocks are prone to making the biggest percentage moves within a short time frame. Some will claim things like the penny stock would go up a great percentage during a particular day. Others believe that they can triple their account today. Then there are some who think they could have purchased and sold close to the top.

The correct course of action is an obvious one in hindsight. However, there’s the lingering question pertaining to if it was even obvious at the moment. Specifically, the moment prior to that stock making that move.

A good chunk of the time, the answer is “no.” On the whole, these penny stocks fade off all day, particularly when they are up over 50%. You will likely lose all the money you use to blindly purchase and hold every small-cap stock gapping up for a 100% move.

In the context of trading, you need to make decisions that draw from the prospects of conditions prior to the setup. You cannot rely on hindsight occurrences alone.

The three types

When it comes to FOMO trading, it will embody its structure in a number of different ways. Below are the three most common ways in which it will appear.

  1. Chasing – Imagine yourself buying the exact top of a move. As soon as you purchase it, the stock reversed and you are left with the bag in hand. As soon as you got stopped out, it began to base, then rally, and then proceed with its uptrend.
  2. Forced trades – Even if you restrain yourself from chasing, your fight with FOMO is not over yet. It is capable of affecting the ways in which you discern opportunities in the market after missing a big trade. After you miss the big buy opportunity, you will notice a separate stock make a move. The setup is not exactly great, but you do not want to be on the sidelines yet again. What’s more, you do not want to miss another big move.
  3. Perceived scarcity – The biggest issue FOMO traders have is the belief that there won’t be another big opportunity in the market. They put so much focus on the opportunity in front of them that they forget the bigger picture. They neglect the fact that there will always be another occurrence of a big move in the markets. The stock that you have your eye on will definitely not be the last stock to make a big move.
What is FOMO

Enter or leave: which is it?

The very task of looking at your own emotions closely when it comes to trading is not always easy. With that said, it should be apparent when you are entering a trade. This is mainly due to your overpowering desire to not miss a move.

What properly defines a FOMO trade is not any specific chart setup, nor does it tie to the stock itself. At its core, a FOMO trade draws primarily from the mindset of a trader. What might come across as a FOMO trade to one trader may be an advantageous setup for another trader. Therefore, the definition of these specific trade types is by virtue of a trader’s belief.

The mindset of not wanting to miss a move is definitely not a solid rationale when you entering a trade. If, however, that is your rationale, it would be wise for you to avoid the trade. As harsh as that piece of advice is, it’s simple and it is for the best. Though, if you have a strategic plan in mind, then that means you are not trading out of impulse. If this is the case, you may proceed like you normally would.

Dealing with FOMO

By far the worst aspect of FOMO trades is the fact that they trigger a sense of anxiety within you. Generally speaking, you only have minutes, maybe even seconds, to react to a move. As a result, your brain overloads from panic. There are a variety of ways to simplify decision making and you can apply those same strategies to FOMO trades.

The influence traders have on each other is staggering. You can look at this relationship as dependent and/or something of a chain reaction. It is pretty easy to get caught up with what everyone else is doing. However, you have to focus on the “why”; as in “why are they doing it?” The worst thing you would want to happen is to get stuck in a populous trade with no exit plan.

When in doubt, exercising capital protection is always the safest move to take. There is no reason to feel any shame in actively avoiding a trade you are not ready for. An alternate move could be to inflate your account and remove yourself from the game.

Above all else, the most important thing to keep in mind is that great moves will come again. Whether it’s sooner or later, the move that you end up missing will not be the last move to occur.

Before you think about entering a trade, you should ask yourself “why?” If you end up possessing a solid rationale, then go forward and test your theory. However, if you do not, then you should move on and hold out for the next play.

Tips for conquering the fear in FOMO

The previous section gave a broad explanation of dealing with FOMO. Now, we will focus on tips and concepts that can help you overcome this specific fear. There are a handful of suggestions that can aid with the handling of FOMO.

  • Filter & Rules – First and foremost, you need to have a trading system. A system will provide you with clear-cut rules pertaining to an array of factors. These include entries, exits, stop and target setting, and both trade and risk management. These sets of rules will ensure that you maintain some structure and consistency in your trading. That is to say, it will just so long as you stick to your rules.
  • Understand both your system implications and your time frame – It’s crucial for you to understand the time frame you are trading in. Ask yourself this: how many trades are you expecting per day or week? On average, how long do you go without a signal? Moreover, what is the typical waiting and holding time? Backtest or check your journal so that you can get those numbers. Doing so will establish a sense of confidence as soon as you know what you are dealing with. On top of that, what you are expecting.

Turning a negative into a positive

The one thing that matters in trading – and also in life – is the present, as well as the future. It’s important to keep in mind that the stock market will always be there. Moreover, there will always be additional opportunities.

With this in mind, another method of coping with FOMO is to shift your perspective. Turning this fear into something good may sound odd, but there are benefits that can come from it. Whenever you experience FOMO in the midst of a big run, change your perspective by focusing on what lies ahead.

Try not to concentrate on what you may have missed. Instead, think about what the next setup will be.

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