What draws us to invest in trending stocks. And do we need them to build wealth?

The story

One of our readers asked whether it’s a good time to invest in a recently IPO’d housing finance stock.

There’s no definitive answer, but I understand the appeal of investing in a rising stock.

Before discussing how to approach such trending stocks, let’s explore why we’re drawn to them in the first place. What’s the psychological play behind it?

Psychological pitfalls: The lure of short-term gains

1. Fear of missing out (FOMO)
When you see a stock constantly in the news, surging upwards, it triggers a fear that you’re missing a golden opportunity.

2. Recency Bias
We tend to give more weight to recent events than past trends, causing us to chase short-term market trends.

Here’s how emotions can drive stock price:

  • A stock rises sharply
  • It creates headlines
  • More investors hear about it
  • More investments follow
  • The cycle repeats itself

The result?

Stock price ends up being at an unsustainable valuation.

So when you buy a hyped-up stock, you’re often paying more than it’s worth because the price has already skyrocketed by the time the hype reaches retail investors like us.

It’s like joining a party when the best part is over. You’re not only late but might also be overpaying for it.

Sentiment or substance, how to tell?

Ideally, a stock surge should be fueled by improved performance or a higher probability of revenue & profit growth. If that’s missing, it’s likely just the hype and could be a sign of a sentimental rally.

A common fundamental metric used to check relative valuation is Price to Earnings, i.e. P/E ratio. It shows how much investors are willing to pay for each rupee the company makes.

If a company commands an unnecessarily higher P/E ratio than its industry peers for no substantial reason, it’s likely overvalued.

To conclude

It’s natural to be intrigued by the excitement around hot stocks, but the reality is that they come with a level of risk that doesn’t align with most retail investors.

The best part is you don’t need to chase the market to build wealth. So avoiding hot stocks is not a missed opportunity—it’s a conscious, wise choice that prioritizes long-term financial health over short-term thrills.