Navigating the Traps of FOMO

Region: Europe
Aug 22, 2023, 4:41:50 PM Published By Yves Renno

I. Introduction

FOMO, or 'Fear of Missing Out,' initially emerged as a social phenomenon in response to the rapid growth of social networks, which began gaining momentum in 2004. Users began sharing their proudest achievements and experiences online, fostering a pervasive feeling that others were leading more fulfilling lives.

Subsequently, the FOMO phenomenon infiltrated the cryptocurrency sector, where influencers and successful entrepreneurs leveraged social media platforms to spark remarkable market rallies.*

A striking example of FOMO in action is the well-known case of Elon Musk and Dogecoin. Starting in 2019, the entrepreneur posted a series of tweets about Dogecoin (DOGE), contributing to an astounding price surge of over +37,000% in under two years. These tweets garnered considerable media attention, further intensifying the FOMO phenomenon among retail investors. However, this rally eventually gave way to a significant correction, resulting in financial losses for many. Notably, FOMO has not only led to investor losses but also triggered lawsuits, with Elon Musk facing a class-action lawsuit accusing him of fraud, market manipulation, and insider trading.

Where does the FOMO sentiment fall on the financial behaviour spectrum?

FOMO appears to be a contemporary fusion of two enduring behavioural biases that have historically roiled financial markets: 'loss aversion' and 'herd behaviour.' The intricate relationship between FOMO and these concepts will be explored in the first part of this article.

II. The Fundamentals of FOMO

FOMO comes into play when individuals learn about others' achievements and fear missing out on similar success. They also gain insights into the investment choices that led to that success, instilling confidence in them to replicate those feats.

Key characteristics of FOMO behaviour include:

  • Greed: A desire for rapid profits.
  • Influencer Proximity or Status: Finding comfort in following decisions made by close influencers, often ignoring objective facts. These influencers are usually perceived as having no conflict of interest, such as friends.
  • Haste in Decision-Making: A rush to make financial decisions to avoid missing out on opportunities.

Along the financial behaviour spectrum, we also encounter:

  • Herd Behaviour: A phenomenon where poorly informed investors blindly follow others' decisions, often disregarding relevant information and their own risk capacity.
  • Loss Aversion: The tendency to lock in profits prematurely out of fear of potential losses and the reluctance to close losing positions, which would mean accepting a loss.

FOMO is inherently linked to these biases. It can lead to herd behaviour, triggering remarkable market rallies when the fear of missing out is widespread. Additionally, during market corrections following a rally, FOMO-driven investors tend to hold onto their positions in the hope of a reversal.

Cryptocurrencies are particularly susceptible to FOMO because they lack robust regulations to control influencers' actions. There is no requirement for inventory disclosure, no established rules against insider trading or market manipulation. Influencers who generate FOMO within their communities are often the first to buy and sell, profiting at the expense of their followers. Smaller cryptocurrencies are especially vulnerable to 'pump and dump' schemes, designed to trap FOMO investors.**

FOMO sentiment also dominated during the speculative bull markets of 2017 and 2021 in Bitcoin.

The initial triggers for these significant Bitcoin rallies could be justified by fundamental factors. For example, the occurrence of a Bitcoin Halving event reduces miner revenues, leading them to hold Bitcoin and await higher prices. However, this does not fully explain the speculative frenzy that typically ensues, fuelled by FOMO investors who are influenced by exaggerated predictions circulating in the media and social networks at the time.

III. Short-Term vs. Long-Term Thinking

The graph below from Glassnode depicts Bitcoin's major rallies over the past 12 years (grey curve), highlighting the rapid reversals that can occur, with the Bitcoin price plummeting by nearly 80% from its peak (maximum drawdown at 80%).

The graph also underscores the success of long-term holders (LTHs). LTH’s are defined as those holding Bitcoin for at least 155 days, in navigating the markets. LTHs, on average, profit during rallies (green curve) and experience losses at the cycle's bottom a year later (red curve). However, as Bitcoin's market consistently reaches new heights in each cycle, long-term holders have frequently benefited from their patience compared to short-term holders.

FOMO-driven short-term thinking is inherently speculative and lacks well-defined rules, such as take-profit and stop-loss levels, or models to support trading strategies. Investors may succumb to emotional impulses, resulting in substantial losses.

FOMO-driven investors often harbor unrealistic expectations, such as attempting to time market reversals precisely or assuming that past performance will predictably continue in the future.

It is advisable to conduct thorough due diligence in cryptocurrency markets, establish and adhere to take-profit and stop-loss levels aligned with your risk tolerance, prioritize diversified long-term investments over high-leverage short-term trading, make informed decisions that consider your financial planning and risk tolerance.

*The value of cryptoassets may fluctuate significantly over a short period of time. The volatile and unprecedented fluctuations in price may result in significant losses over a short period of time. Any Cryptoassets may decrease in value or lose all its value due to various factors including discovery of wrongful conduct, market manipulation, change to the nature or properties of the Cryptoasset, governmental or regulatory activity, legislative changes, suspension or cessation of support for a Cryptoasset s or other exchanges or service providers, public opinion, or other factors outside of our control. Technical advancements, as well as broader economic and political factors, may cause the value of Cryptoasset s to change significantly over a short period of time.

**The prices of Cryptoassets fluctuate, sometimes dramatically. The price of a Cryptoasset may move up or down, and may become valueless. It is as likely that losses will be incurred rather than profit made as a result of buying and selling Cryptoassets.