The Psychology of Investor Behaviour: Why Retail Investors Are Attracted to Both Hyped and Distressed Stocks

Retail investors are known for being drawn to stocks that have extreme price movements, either shooting up in value or collapsing in value. These stocks are often characterised by hype, such as with new technology stocks, or by distress, such as with stocks of companies in financial trouble. However, the question remains: why are retail investors so attracted to these types of stocks, even when higher quality assets may offer more stable returns?

One reason for this behaviour is the tendency of retail investors to succumb to the fear of missing out. When a stock starts to rise rapidly in value, investors may feel a sense of urgency to get in on the action before it's too late. This can lead to a self fulfilling cycle of buying that further drives up the stock's price, as more and more investors jump on board. Buying a highly hyped stock carries several risks, including the possibility of overpaying for the stock and the potential for the stock price to drop rapidly if market expectations are not met. Additionally, highly hyped stocks may represent companies that are untested or unproven, with unknown growth prospects and risks that are difficult to assess. Finally, the hype can lead to increased volatility and potential losses for investors who may be unable to react quickly enough to sudden price changes.

Similarly, the fear of missing out, may contribute to retail investors buying distressed stocks. This may happen when investors see other market participants attempting to take advantage of fall in a stock price and feel pressured to do the same before prices rise again. The belief is that a stock that has declined in price may be undervalued and present an opportunity for a bargain purchase. Retail investors may see stocks that have recently collapsed in value as offering the potential for significant gains if they can turn around the company's fortunes or if the market eventually recognises its true value.

However, investing in distressed stocks can be incredibly risky, as these stocks may represent companies with fundamental problems that are difficult to solve. Additionally, these companies may have debt burdens that can be difficult to service, or may face regulatory or legal challenges that limit their growth prospects.

Moreover, retail investors may also anchor on the stock's previous high value and believe that it will eventually return to that level, even if the company's fundamental problems suggest otherwise. This can lead investors to overlook important information and risks, and to make investment decisions based on outdated information.

Overall, the combination of the fear of missing out, the allure of buying the dip, and anchoring bias can create a potent cocktail that leads retail investors to invest in hyped or distressed stocks without fully considering the risks involved. As a result, it is important for investors to remain vigilant and to carefully evaluate the fundamentals of any company before investing in its stock. Retail investors should focus on investing in high quality assets that offer stable returns over the long term. By avoiding the temptation of hyped or distressed stocks, investors can build a diversified portfolio that minimises risk and maximises returns