There is a stock that all of a sudden has become everyone’s favorite. Its value has increased by 30% within a very short period of time; everyone is talking about the stock, discussing how well off financially they have become. At one moment, you decide to check out your trading application and ask yourself, “Would it be wise to buy it before it goes even higher?” This is what happens when many people chase hot stocks.

There is nothing wrong with stocks that go up in price. What is wrong, however, is that people purchase them because everyone else does the same thing. At that point, there may have been no room left for any increase in the stock’s value. There should be a strategy other than following hot stocks.

Why Is It Going Up?

Before you decide to buy into an emerging stock, you should know why it is going up. Is it making more money? Has it secured a large deal? Or is there some change in the business environment for the better? Or is it just going up due to market noise? The fundamentals of the business can justify the increase in value of the stock. An increase in value due to speculation may not hold much water.

Look into the Company’s Fundamentals

Don’t just concentrate on the chart of the stock; look at the fundamentals behind the stock.

Consider:

• Revenue growth
• Profit growth
• Cash flow
• Debt levels
• Profit margins
• Return on capital
• Competitive position

A company that shows strong fundamentals may be worth looking into regardless of whether it is trending on social media.

Valuation

Just because the company is great does not mean it is a good buy at any price. Let’s imagine that the company has steady growth in earnings, however, the stock price is rising far quicker than the company’s earnings. Then the valuation may be stretched. Compare the ratio of price/earnings, price/book value and other valuation ratios with company’s historical figures as well as with those of its competitors. The important questions include both “Is this a good company?” and “Is this price justified?”

Don’t Be Driven by FOMO

When one fears to miss an opportunity, it feels as the only solution to purchase the stock now. However, market opportunities arise all the time. If the stock already has strong gains and you do not know the business or the valuation of the company, then your decision not to purchase the stock is also a choice. Not everyone has to buy each rising stock.

Build a Watchlist Instead

Instead of immediately buying a hot stock, add it to a watchlist.

Track its:

• Earnings
• Valuation
• Business developments
• Industry outlook
• Price movements

You get time to study the company without acting impulsively. In some cases, the stock rises further. In other cases, the excitement subsides. Regardless, you get more time to know the company before committing any cash.

Invest According to Your Investment Strategy

The stock that everyone is talking about at the moment should not guide your investment decisions. You must consider what your investments mean to you and your risk appetite. If your investment horizon is long-term, look for firms that will grow sustainably. If your horizon is short-term and you are just trading, have an entry, exit and risk-management strategy before entering the trade. This helps you tune out any market noise.

Diversification Is Still Important

Putting all your eggs in one basket, in this case, one “hot” stock, puts your portfolio in a position of significant risk. The diversification of investments through companies, sectors or appropriate assets will serve to reduce the effects of underperforming in one particular investment. It does not remove all risks but ensures that one bad choice will not dominate your portfolio.

Do Not Chase the Stock. Chase the Reason.

There will always be the next great stock somewhere out there in the market. But chasing each rally could result in you acting emotionally, overpaying for a company and taking on more risk than necessary. Take your time. Learn the business. Study the fundamentals. Assess the valuation. Identify your risk tolerance. And then make up your mind. You do not have to be the first person to buy the stock. A sound investing decision does not require speed but rather knowledge and discipline. While everybody else is wondering how far a stock could rise, you should be asking yourself why the company is worth buying.

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Frequently Asked Questions

1. What does chasing hot stocks mean?
   Chasing hot stocks means buying shares mainly because they are rising rapidly, trending in the market or attracting significant investor attention.
2. Why is chasing stocks risky?
   You may end up buying after a large price increase, when valuations are already high. If the momentum reverses, losses can occur quickly.
3. What should I check before buying a trending stock?
   Look at the company’s financial performance, debt, cash flows, valuation, competitive position and the actual reason behind the stock’s price movement.
4. Should I avoid stocks that have already risen sharply?
   Not necessarily. A stock can continue rising if its business fundamentals justify the valuation. The important thing is to assess whether the current price is reasonable.
5. What is a better alternative to chasing hot stocks?
   Build a watchlist, research companies based on fundamentals, set clear investment criteria and make decisions based on your financial goals and risk tolerance rather than market hype.