The Allure and Peril of Chasing Top ASX Gainers

The allure of watching high-performing investments is undeniable. Imagine you stumble upon a list of Australian traded securities that boast triple-digit returns over the past year. While it’s exciting to want to join the action, we demonstrate why this approach is fraught with danger.

Here they are: 12-month gains for each of these ASX investments are: 164.2%, 135.3%, 132.9%, and 108.8% respectively.

For many investors, this sparks a desire to jump in and invest to capitalise on such seemingly guaranteed gains. However, two crucial elements often get overlooked in the excitement.

Hint: these concepts start with the letters V. and P.

While seemingly straightforward, these precepts can be the difference between profiting handsomely and experiencing unexpected losses, even for seasoned investors with top-performing assets.

In this article, we’ll explore the inherent risks of chasing gainers and explore strategies for navigating them. As well as provide alternative approaches to consider when building a robust investment portfolio.

Demystifying Volatility: The Price Rollercoaster

Volatility, in essence, measures the degree to which an investment’s price fluctuates over time.

High volatility translates to significant price swings, both upwards and downwards, within short periods.

While potentially lucrative, this characteristic can be nerve-wracking for investors unfamiliar with its implications.

The deception of the highest annual gainer

While the annual returns are undeniably impressive, they paint an incomplete picture. A 160% plus annual return might sound like a guaranteed path to riches.

However, the reality is that the price may have experienced numerous 10-20% dips throughout the year. These sudden drops can trigger emotional responses in investors, leading to hasty decisions that can undermine their long-term goals.

Example: The Trap of Panic Selling

Imagine being captivated by a stock or an ETF’s stellar annual performance and deciding to invest after a 150% gain.

Shortly after, the price plummets 15% in a single day. This experience, not uncommon in volatile investments, can lead to panic selling – the act of selling an asset at a loss due to fear of further price declines.

This strategy often backfires for two key reasons:

  1. Locking in Losses: By selling during a dip, you crystallise a loss not just a paper loss. This means the loss becomes permanent, regardless of whether the price rebounds in the future.
  2. Missing the Rebound: Often, these short-term dips are followed by price recoveries. Investors who succumb to panic selling miss out on the potential for the price to regain its upward trajectory, potentially negating the initial loss.

The Power of Patience

The historical performance of these high-performing ASX stocks or ETFs suggests that despite significant short-term volatility, they’ve delivered impressive returns over a year.

Does that mean these sized gains will continue? The fact is:  the risk is transferred to the investor buying at a 12-month high price.

The key takeaway? Patience is paramount. Investors with a long-term outlook are better equipped to weather the inevitable price fluctuations and potentially benefit from the overall upward trend.

Which securities are the top 12-month gainers in our example?

These are the leading ETF gainers in Australia on the ASX and CBOE:

Global X 21Shares Bitcoin ETF (ASX: EBTC) Gain +164.2%

Betashares Crypto Innovators ETF (ASX: CRYP) Gain +135.3%

Global X Ultra Long Nasdaq 100 Hedge Fund ETF (ASX: LNAS) Gain +132.9%  

Global X 21Shares Ethereum ETF (ASX: EETH) Gain +108.8%

Analysis

The Global X 21Shares Bitcoin ETF (ASX: EBTC) exemplifies this concept. While boasting a 164.2% return over the year, it experienced periods of significant price drops.

However, investors who were patient and held on through those dips and were patient are better able to benefit from the overall upward trend that led to the impressive annual return.

Editor’s note: This analysis does not make any recommendations about the ETFs in this article. The ETFs are used for illustrative purposes and for general education only. Do your own analysis of stocks and ETFs, or consult your financial advisor.

Leverage can amplify gains and losses.

The Global X Ultra Long Nasdaq 100 Hedge Fund ETF (ASX: LNAS) magnifies both gains and losses.

While leverage can enhance returns in a rising market, it can also amplify losses during a market correction and downturn. As sure as night follows day, markets will correct from time to time.

The adage holds. Markets go up the stairs and fall by the elevator.

Investors may experience significant erosion of capital if the market moves against their positions.

Beyond Volatility: Other Risk Considerations

While volatility and patience are enormously important concepts for an investor to understand, it’s not the only risk associated with high-performing investments.

This is especially so for those focused on innovative ETFs or sectors. Here are some additional considerations:

  • Price Swings: High volatility leads to significant price swings in short periods, making it challenging to predict the direction of the market accurately. While these ETFs may experience rapid gains, they can just as quickly incur steep losses due to market fluctuations.
  • Risk of Overvaluation: Exceptional returns over a short period can lead to overvaluation of the underlying assets, creating a bubble-like scenario. When prices are inflated beyond fundamental value, a correction becomes likely, resulting in potential losses for investors who bought at peak prices.
  • Market Risk: The broader market environment can significantly impact even the most promising investments. An unexpected economic downturn or industry-specific issue can lead to price declines, regardless of an ETF’s past performance.
  • Liquidity Risk: Liquidity refers to the ease with which an investment can be bought or sold. Some high-performing ETFs, particularly those focused on niche sectors, may have lower liquidity. This can make it difficult to sell your shares quickly if needed, potentially forcing you to hold onto them even during a downturn.
  • Currency Risk: For investors in countries with currencies different from the underlying assets of an ETF, currency fluctuations can impact returns. A strengthening local currency can erode gains made on a foreign investment.
  • Management Fees: ETFs typically come with management fees, which can eat into your returns over time. While some high-performing ETFs may have lower fees due to their popularity, it’s still crucial to consider the ongoing costs associated with the investment.

Beyond the Top Gainers: Building a Balanced Portfolio

Diversification Across Asset Classes

Spreading your investments across various asset classes like stocks, bonds, real estate, and commodities can help mitigate risk.

Each asset class has its risk-return profile, and by including a mix in your portfolio, you can reduce the overall volatility.

Investing for the Long Term

A long-term investment horizon allows you to ride out market fluctuations. High-performing ETFs, while tempting, can be volatile in the short term.

By adopting a long-term perspective, you can focus on the overall upward trend of the market and avoid making impulsive decisions based on short-term dips.

Dollar-Cost Averaging

This strategy involves investing a fixed amount of money into an investment at regular intervals, regardless of the current price.

This approach helps average out the cost per share over time and reduces the risk of buying in at a peak price.

Index Funds

These passively managed funds track a specific market index, such as the S&P/ASX 200 or the S&P 500.

They offer a low-cost and diversified way to gain exposure to a basket of Australian and U.S., equities without the need for active stock selection.

While index funds may not generate the outsized returns of top gainers, they provide a more stable and predictable path to wealth creation over the long term.

Considering Risk Tolerance

Understanding your risk tolerance is crucial. If you’re risk-averse, focusing on low-volatility investments like index funds, government bonds dividend-paying stocks or ETFs may be a better fit.

Conversely, suppose you have a higher risk tolerance and a long-term investment horizon. In that case, you may be comfortable allocating a portion of your portfolio to high-growth, high-volatility assets like some of the ETFs mentioned earlier.

A riskier asset might have a place in your portfolio. That depends on your investment objectives and answering the question:  Why am I considering investing in this particular stock or ETF?

Conclusion

Focusing solely on top gainers can be a risky strategy. A well-diversified portfolio that considers your risk tolerance and investment goals is the key to long-term success.

 

JustStocks Advisor
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