Melt Up
Candlefocus EditorAt the heart of a melt-up is investor sentiment and herd mentality. The rapid rise in prices may inspire more people to believe that the security or market index is highly valuable, or it may draw in investors who are afraid of missing out on the potential for high returns.
Whether a resulting security or the stock market as a whole is really overvalued or not, it won't be possible to tell until the bubble eventually pops. When a melt-up occurs, therefore, investors should take a moment to step back and assess the economic health of the country and the company at the heart of the underlying security.
The technical indicators that gave rise to the melt-up might be pointing to a strong market in the short-term, but are there also indications of a broader economic recovery such as increasing GDP, low unemployment and a rise in consumer confidence? Are there any signs of warning signals such as low business investment or a weak housing market? It’s important to understand the fundamentals that usually drive the price of assets, rather than simply following the herd.
At the level of individual stocks and securities, it's also important to consider whether a rise in price has come as a result of fundamental changes at the company. For example, has the company shifted its strategy, released some promising new products or boasted industry-leading figures?
By taking the time to assess the situation properly investors can avoid making a poor decision to buy into a melt-up. The real value of any security will be revealed in the longer term, and by changing their focus from the highs of the melt-up to the economic environment and fundamentals underlying each security, investors can make better judgments about the value of an asset.