Penny Stocks, Wild Speculation, and Investor Stampedes

By Peter Leeds

Like all investments, penny stocks can be impacted by investor stampedes. One of the first documented investor stampedes was not even related to the stock market, but that’s the point — this is not a stock market issue, it is a human psychology issue.

In 1637, in the Netherlands, the people got caught up in a speculative frenzy related to tulip bulbs. The flowers were coming over from Asia, and their value seemed to keep increasing, which only served to fuel the frenzy even more.

Eventually, the most sought-after tulip bulbs sold for more than ten years of an average salary. Certain bulbs were exchanged for entire houses. The investor mania was in full swing.

The main driving force seemed to be that the prices just kept climbing — you could overpay for a flower, knowing that the next person would overpay even more. Everyone kept buying and profiting. Some bulbs were reported to have changed hands between speculators ten times in a single day.

That was the peak of the Dutch tulip bulb mania. The sudden crash was so severe that besides financially destroying the financial lives of much of the population of the Netherlands, it actually put the entire nation’s economy under strain.

Since then, history has seen plenty of manias: the California Gold Rush, the birth of America’s 1,800 automobile manufacturers (only three remain), the sudden popularity of the Iraqi dinar, the dot-com bubble, marijuana stocks, Bitcoin-related investments, green energy, 3D printing . . . the list goes on.

Not to suggest that green energy, automobiles, or 3D printing are bad businesses or trivial technologies. During any mania, there are overpriced investments, based almost solely on a good “concept.” Typically, the underlying stock market investments destroy far more dollars than are generated for shareholders. For example, most money invested in the 1,800 automakers from the 1890s to the 1920s was lost, and only the Big Three survived. Even so, General Motors still went bankrupt on June 8, 2009, costing shareholders 100 percent before GM emerged as a new bank-owned and creditor-owned entity on July 10, 2009.

Because each stampede is born in a different region or time in history, or is based on a brand-new technology or social situation, each has its own unique set of price drivers. Still, they do always share a common theme: The crowd is doing something brand new and it’s working pretty well . . . at first, at least.

This early success acts as proof to people that they made a smart move, as they brag to their family and friends. If they aren’t shouting from the rooftops about the easy gains they’re grabbing, the media will usually do it for them by talking about the latest craze. The family and friends of the early investors get involved next. More buying keeps the trend going. The media gets louder. The profits swell. Eventually, everyone has scraped together as much as they can (even those who were cautious to get involved at first), and they’re all in. Of course, when there is no one left to buy, the stampede immediately collapses on itself.

Typically, people remember their losses more than their gains, their mistakes more than their successes. Likewise, most investors who get swept up in a stampede don’t remember their early gains they might have made (on paper at least), as much as they think of the collapse at the end.