Bitcoin hits $100k: the new FOMO phase

A friend of mine (a real one; this is not me) has made a life-improving amount of money out of Bitcoin this year. This has left the rest of our group wrestling with mixed emotions. Above all, we are full of admiration for his timing and, even more so, his willingness to back his bet with conviction. The post-Trump surge in the price to over $100,000 has made a material difference to his finances. After persistent encouragement, he has now taken his initial stake off the table, so he’s in for nothing.

But if we’re honest, we are also envious, contemptuous of our own timidity and prey to FOMO. This is a dangerous place for investors to find themselves. ‘Fear of missing out’ sounds simple but it is a snake-pit of complex and painful emotions and psychological biases. Uncontrolled, it risks compounding the initial error of omission with another of mistimed and ill-conceived commission. As James Goldsmith once said: ‘when you see a bandwagon, it’s too late’.

The first dangerous emotion that investment by-standers must contend with is regret. Imagining ‘what might have been’ is what psychologists call counter-factual thinking. How much financial regret we feel is determined not just by what happened but by what we think could have happened in a parallel universe where what we should do is always obvious.

The regret is deeper if you consciously, or through idleness or distraction, chose not to do what someone else did. I always remember Jim Slater telling me: ‘the difference is I did it.’ My friend and I had conversations about Bitcoin when the price fell below $20,000 but I was unable to overcome my belief (which I still hold) that crypto has no intrinsic value and so can only ever be supported by the Greater Fool Theory.

The second psychological dead-end we can find ourselves going down is wishful thinking. As Morgan Housel says in his excellent book, The Psychology of Money, the more you want something to be true the more likely you are to believe a story that overestimates the odds of it being true. This is why we accepted twaddle about eyeballs and clicks during the dot.com bubble 25 years ago. And it is what’s behind the rationalising of the Bitcoin mania today - the impact of ‘halving’, adoption curves and other after-the-fact justifications.

The only thing we need to know about Bitcoin is that there is a limited number of them and always will be. That means that more people wanting to buy than sell will push the price higher until such time as that balance is reversed. When that happens, the price will have a Wile E Coyote moment and realise that there is nothing to sustain it in the face of more sellers than buyers.

The third mental bias that can suck us in during manias like this is herding - better known as ‘the madness of crowds’. As John Templeton said in his preface to Charles Mackay’s classic study of bubbles, ‘human nature is drawn like a moth to the flame by the speculative fads of the marketplace…basing our investment decisions on the actions of the crowd can be a disastrous gamble.’

Jason Zweig in his fantastic book, Your Money and Your Brain, relates the story of Alfred Sloan, chairman of General Motors, who once adjourned a board meeting with these wise words: ‘gentlemen, I take it we are all in complete agreement on the decision here….then I propose we postpone further discussion of this matter until our next meeting to give ourselves time to develop disagreement and perhaps gain some understanding of what the decision is all about.’

One other psychological flaw that’s relevant here is anchoring. This is the importance that investors will invariably attach to an arbitrary number, in this case the $100,000 that Bitcoin crossed. If, as is likely on the basis of crypto’s volatile recent history, Bitcoin falls to $75,000 or even lower, it will be tempting to believe it is undervalued because it was recently ‘worth’ $100,000. The price performance of countless internet stocks a generation ago confirms that a share that has fallen 30% can still fall by another 100%.

James Montier, in yet another excellent book on this topic, Behavioural Investing, talks about ‘bubble echoes’, the tendency for investors to inflate a bubble one more time after it first bursts. He notes an important difference between the two phases: the first is a bubble of belief, the second is one of overconfidence - investors know the subsequent bubble is not supported by fundamental value but they are sure they will be able to get out in time.

How can we avoid these four mental traps? Three things can help prevent our rational brains from being overwhelmed by our emotions, which is at the heart of all of them. First, we can use words to counter the emotional power of images. Rather than looking at a chart of Bitcoin romping up the page in a visual rebuke of our failure to act, we should engage the reflective part of our brain that is triggered by the nuances of language. Speaking it calms the nerves.

Second, we should track our feelings. Jason Zweig suggests keeping an investment diary. It will show us that we tend to become more optimistic as prices (and risks) rise and to become gloomy when they fall. We need to train our brains to use our emotions as contrarian indicators: enthusiasm is a cue to consider selling; despair can be a trigger to buy.

Finally, we should keep away from those conversations around the water cooler. At the very least we should only join them once we have written down what we think about the investment being discussed, and why. Without this, there is almost no chance that we will be able to swim against the tide. FOMO will sweep us away.

This article was originally published in The Telegraph.

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