4 Tips for Investing in Psychedelic Stocks During a Market Downturn

In times of great stock market volatility, as we are experiencing right now with psychedelic stocks and the market more widely, I am reminded of a famous Warren Buffet quote: “Be fearful when others are greedy, and greedy when others are fearful.”

What Buffet is arguing, is that the best buying opportunities arise when everyone else is selling good investments, driven by irrational short-term fears. 

However, in order for this strategy to work, you need to be investing in good companies. After all, if you invest in a company just because it is down 50% on the age-old maxim of “buy low, sell high,” with no fundamentals backing up the thesis that the stock will in fact rise again in the future, well then, you’re just gambling.

Which brings us to psychedelic stocks. Many of the flagship publicly traded companies in the psychedelic medicines game have seen their stock prices decimated over the last 6 months. For example, MindMed (Nasdaq: MNMD) has plummeted 62.67%, atai (Nasdaq: atai) has crashed 65.49% and Cybin (NYSE: CYBN) has nose dived 65.89%.

So which category do psychedelic companies fall into: investable companies that will rise again like a phoenix, or bad investments that will go up in flames, using your money as kindling? 

In this article we will try to sort through this central question, and give some helpful tips on how you should navigate the current volatility and perhaps even a full on market crash (though, of course, nothing here is financial advice).

Tip 1: Be Responsible with Your Money

If you are investing in psychedelic stocks, you NEED to understand that this sector will be highly volatile, and is intrinsically speculative. Even if I, and many others, believe that a handful of psychedelic companies will ultimately be successful, there is no guarantee.

We are speculating here. We believe that psychedelics have the potential to heal hundreds of millions of people with untreatable depression, anxiety, PTSD, addiction and more. This would unlock markets in the tens of billions of dollars. But ultimately, these companies will need to prove beyond a reasonable doubt that their medicines work in clinical trials, and that their leaders will steer these heavily diluted companies to profitability. This is a steep task.

Therefore, if you are investing in psychedelics, you must be prudent and not expose yourself to too much risk. This means not going “all in” on any of these companies or the sector as a whole.  Personally, I am limiting my exposure to the ENTIRE psychedelics industry to 5% of my total portfolio, and my (admittedly self-bestowed) title is The Psychedelic Investor!

If we do see an economy or market wide crash as we did in 2008 (and by the way, I am not saying this will happen, though there are warning signs), it will be speculative growth stocks that get crushed first, and the hardest. If you do have 20%, 30%, or 50% of your portfolio in psychedelic stocks, well then in the event of a crash, you will be in for a rude awakening.

It is okay to make speculative bets. After all, these are the investments that can have the biggest pay off. But like all things in life, you need balance. Be responsible with your money.

Tip 2: Spread Your Risk

Even if the thesis that psychedelic medicines will utterly disrupt the pharmaceutical industry plays out as I predict, there is no guarantee that specific companies will be the winners. 

Unless you are a scientist with intimate knowledge of every psychedelic company’s next generation compounds and clinical trials, you don’t know which psychedelic stocks will ultimately be the winners. For example, who’s next-gen psilocybin will be most effective? Cybin’s? Mindset’s? One of the dozens of other companies working on it? I don’t know, and neither do you.

In a scenario like this, when you believe in the industry but it’s too early to pick winners, it may be best to spread your risk and invest in the whole industry. You can do this either by creating a portfolio of psychedelic stocks, or by investing in a premade portfolio such as an ETF. My favorite ETF is the actively managed Advisor Shares Psychedelics ETF, ticker symbol $PSIL. The idea is that the gains of the winners will more than make up for the losses of the losers.

That doesn’t mean you CAN’T buy individual stocks in this field. I own a few of my favorites that I believe to be the most stable. But particularly if we see a market downturn, many individual companies will likely go out of business. If that happens, you need to be prepared.

Which brings us to our next tip…

Tip 3: Check the Balance Sheets

The psychedelics industry is a capital intensive one. Companies need to run expensive clinical trials, which can cost upwards of tens of millions of dollars. As these companies are (mostly) pre-revenue, the best way for them to raise capital and fund their projects is through dilution. 

And while this is all fine and dandy when you have a huge market cap, if prices of psychedelic stocks get decimated in the short term as part of market collapse, many of these companies’ access to capital will be severely limited. 

Therefore, before making an investment in an individual company, make sure you research how much cash on hand they have and how quickly they are spending money. For example, atai, the best funded company in the sector, had more than $430 million in cash and cash equivalents at the end of quarter 3 2021, and was only spending around $31 million per quarter. 

This means atai can survive for more than 3 years without having to raise capital again. Of course, this doesn’t mean in and of itself that atai is necessarily a good investment, but it does mean that they can weather coming economic storms.

On the flip side, if you are thinking of investing in a company that is spending more in a year than they have on their balance sheet — and there are quite a few companies in the psychedelics space who are doing this — you may want to rethink.

If there IS a market crash, this sector, at least in the short term, will likely be crunched even further. If a company needs to start diluting by 10-20% EVERY QUARTER to meet its immediate financial obligations, well let’s just say that may be a company you want to avoid.

Tip 4: Hold, Don’t Look at Day to Day Prices, and Add More If You Can

If you are investing in the psychedelics space, you MUST understand that it is a long term investment of five to ten years.

If the thesis that psychedelic medicines disrupting the mental healthcare industry worth tens of billions of dollars bears fruit, then it WILL NOT MATTER that in the interim stock prices fell drastically during a market downturn.

If you feel confident in this thesis, and the companies you picked can financially survive a downturn, you don’t have to panic when you see one of your stocks down 10% on the day. 

Personally, I don’t even look at the stock prices most days. It’s irrelevant to me. I have a few positions in companies I know have little risk of running out of money, and then a larger stake in a couple ETFs. I am confident that history will judge the thesis to be correct, so I am holding. There is no need to stress myself out by checking the stock price daily.

Getting back to the quote which opened this article, if you have money to invest, you are confident in the thesis, and you are being responsible with your money, now may be a great entry point into the psychedelics sector.

People are fearful. And if they aren’t now, they will be if a crash comes. So if you wish to add to your position, do so responsibly.

To close out the article, I have no idea if there will be a crash or not. I do not have a crystal ball. But many intelligent people are arguing that all the warning signs are there, so it is better to be safe than sorry.

Full Disclosure: James Hallifax holds positions in MindMed, Compass Pathways, atai Life Sciences, the Horizons Psychedelic Stock Index, and the Advisor Shares Psychedelics ETF

The views of the author are for informational purposes only, and should not be construed as financial advice, but rather his own personal opinion. Furthermore, the views of the author are not necessarily representative of Psychedelic Spotlight. His views and opinions are his own.