Momentum Traps – how to avoid the siren song of overhyped stocks

Faced with choosing between a $10 bottle of wine and a $90 bottle of wine, which would you go for? In one experiment – with the prices of each wine clearly marked – nearly twice as many people preferred the taste of the most expensive bottle. But unknown to the volunteers, the two wines were exactly the same.This test was carried out by American researchers investigating how pricing can influence the brain’s perception of how ‘pleasant’ something is. Told it’s expensive, we tend to like it all the more. It’s an example of what behavioral scientists say is a flaw in human emotions that causes us to be overly-influenced by a good story.The read across for investors could hardly be more stark. Stories in the stock market are like a magnet. With herds of followers, these popular shares typically boast eye-catching price momentum. Yet a good proportion of them hide deteriorating fundamentals and stretched valuations that can be harder to spot (and, for some, easy to ignore). These are the market’s glamour stocks which may well be Momentum Traps – stocks where a sudden change in sentiment could see their momentum crash.Of all the dangers that investors…