By Rishit Jain
For a field defined by complicated and extensive mathematical modelling and absolute precision in logical decision-making, finance is often contaminated by a sentiment many know very well: falling for the trends. This irrationality has historically been a common ingredient for devastating aftermaths and has led to several historic crises.
Dot-com bubble
One of the purest examples of excitement and corporate fervour overriding decision-making is the dot-com bubble. With the development of the internet came immense expectations for revolutionizing consumerism, opening new avenues for businesses and most importantly, an expectation of rocking the stock market. This certainly reflected in American stock exchanges, where NASDAQ a commonly used index for equity performance in the Nasdaq stock exchange spiked from roughly $750 in 1995 January to a peak of $4800 in March 2000. This 640% jump in just a bit over 5 years for a stock exchange index is absolutely phenomenal.
To put things into perspective, out of all the BRICS known as the greatest emerging markets in the world the largest growth in equity markets in the last five years has been in India, witnessing a growth of 205%.
This sharp rise was followed by a devastating fall down to roughly $1200 by September 2002, losing 75% of its value consistently over 2 and a half years. Technology giants such as Cisco and Qualcomm lost more than 84% in value, as several firms went bankrupt, unavailable to recover from the abrupt panic and realization that ensued upon the realization of the hollow valuations of such firms.
The sheer excitement related to the dot-com revolution caused investors to splurge on any initial public offering (IPO) that ended with “.com”. As a result of this, many firms with a poor business plan and no actual revenue or profitability were valued at senseless heights. Thus, when speculation on interest rate hikes came about and Japanese instability ensued, uncertainty lingered, as immense volatility in these stocks brought fear.
The United States v Microsoft case of 2000 on monopolization led to 21.25% loss in stock value in just 2 weeks, while Microstrategy lost 95% in less than 2 months due to pure investor speculation. Such instances shocked investors who rapidly pulled money out, leading to one of the most devastating crises the world has witnessed in financial markets.
Snapchat and Cryptocurrency crisis
In a very similar example, Snap Inc the firm behind the popular social media platform Snapchat launched their IPO in March 2017 at $17, witnessing a 44% spike at the end of their first closing day. The hype surrounding the company led to an unprecedented level of speculation, that was quickly followed by an acute crash, where today the stock continues to fall after $11.63 having witnessed a 53% fall since then.
Another celebrity in the finance world we are all acquainted with is Bitcoin. While the concept of a cryptocurrency is certainly revolutionary, and possibly capable of substituting the physical realm in which currency is dealt in today, irrationality still seems to seep through.
With several cryptocurrencies in the market and this 13-letter word starring in global newspaper front pages, several unaware investors placed a lot of money in investments solely on the brand of the investment, rather than its quality. Bitcoin, for example, priced at $0.06 in 2010, shot up to more than $17,500 in 2017. While factors such as increased electronic payments certainly contributed to this hike, the irrationality of investors played an undeniable role in the 30,000,000% jump.
When news broke out about China clamping down on illegal transfers through Bitcoin and a South Korean exchange being hacked, these same investors lost as their investments fell in valuation by 65% to around $6,100. If investors were only involved due to their true belief in a future of cryptocurrency and a long-term plan for a complete overhaul of physical currency, such minor hurdles wouldnt have led to such catastrophic consequences. From its peak, the cryptocurrency continues to fall as it meanders around $6,700 today.
Ethereum also witnessed similar volatilities. From its hike in January (when China announced its aggressive clampdown) when it was valued at ~$1350, Ethereum crashed by 73% in just 3 months. This was valued at $1.33 less than 3 years prior to its peak, also having witnessed a magnanimous ~100,000% appreciation.
Pattern of irrationality
When revolutionary, new technology is released there is excitement surrounding the same, which brings in investors keen to buy the brand associated with the technology. However, this is where the problem resides as they are not investing in the technology but rather the brand that it represents. All the buzz surrounding new developments usurps the impulse to be careful, becoming the tragic flaw of the investment.
As technology resides mostly either in the realm of the youth or involves technicalities far beyond the laymans knowledge investors make poor decisions. In fact, investing legend Warren Buffet once that no one should invest in a business you (one) cannot understand. This is the same man who failed to invest in Google and Amazon, some of the worlds most valuable firms today, as he did not have faith in firms he could not comprehend. Yet, he is regarded as the brightest investor in the world.
From the emergence of the internet and social media platforms or that of cryptocurrencies consisting of mind-boggling algorithms trends are dangerous to the financial sector. It is important to understand such historic failures and keep note of the next big boom that could end up being the fatal choice.
Rishit Jain is a writing analyst at Qrius