The Investing Bubble – Booms and Busts of Investing

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Investing can seem really scary. If you’ve thought about doing it in the past but are worried and think the whole idea sounds awful, I’m here to tell you that it doesn’t have to feel that way. Today, I want to focus on the investing bubble and what this means for you.

Why is Investing So Scary?

The reason it seems so scary is because people can — and do — lose money. As human beings, we do not like losing our investments. We are 10 times more risk averse about losing money than we are about gaining it. We feel those losses a lot harder compared to the thrill of making money, which is why so many of us decide it’s safer to not get involved. 

However, the reason why people lose money is because they make erroneous decisions at the wrong time, and it costs them. Which means for those of us on the outside looking in, it can be easier to just not get involved. You’ll have visions of scenarios similar to those in the Wolf of Wall Street, and in self-protection mode, will affirm, “nope, not going there!” On the other hand, you might be really tempted to jump in, just because everyone else is.  

If you’ve taken my money personality quiz, you might have an idea about which archetype you are. So, if you’re more of an “Accumulator”, you might think, “Yeah… I’m not touching this with a barge pole!” But if you’re more of a “Maverick” (like me!) it might be a bit more tempting to jump in feet first and get involved, ‘cause it looks awesome! 

I believe investing is essential when it comes to the overall management of your money, but you do have to be cautious. Investing does not come without risk, so let’s look at the downsides. 

The History of Investing (Debatable)

It’s widely believed that the history of investing originated in Amsterdam, where (allegedly) the world’s first stock exchange was established in around 1602. But some people disagree with this and believe the markets started much earlier, with many other representations of stock investment markets around the world. For this purpose, however, let’s look at Amsterdam. Tulips specifically; because this is a great way to understand what a “bubble” is.

The Tulips Boom and Bust Story – Tulip Mania

During the Dutch Golden Age, the tulip swiftly became a much-desired, very fashionable accessory for the home. With its beautiful colours and unusual shape, demand rocketed, and the price of the tulip increased exponentially. Seemingly overnight, tulips became a coveted, luxury item and couldn’t be produced quickly enough. 

Contracts for 100s and 1000s of tulips were exchanged before they’d even been cultivated. These highly sought-after blooms were selling like crazy; investors offered to pay even more, with nonstop counter offers coming in. 

Then the market crashed. 

Source: https://www.history.com/news/tulip-mania-financial-crash-holland

Coupled with the Bubonic plague — people staying home with it being too dangerous to go out — (Read: COVID!), everything collapsed. Doubt and mistrust replaced the previous confidence in the market, and the price of tulips plummeted. 

Take a look at the above diagram of the Tulip Price Index from 1636 – 1637, and its activity over that timeframe. As you can see, the price grew higher and higher, before depleting rapidly. You can see how the value climbed exponentially, then dramatically dropped. This is where investors lost money. 

The Anatomy of a Bubble

Next, we have the Anatomy of a Bubble by Dr Jean-Paul Rodrigue. Essentially, you can see the similarities between this and the Tulip Bubble. It’s a pattern. When a new company or product launches, the smart people get involved early on when the price is low. The price starts to increase as demand increases, and shares get more and more expensive as time goes on. 

Institutional investors ­— those with pension funds and hedge funds — get involved while the price is still low. As they start buying, the price goes up, and stock levels go down. Cue media attention and public enthusiasm, and the price rises exponentially. 

You may recall when Bitcoin first attracted the attention of the general population. Suddenly, everyone knew about it. Your hairdresser, your taxi driver. There was a hubbub of excitement and enthusiasm as would-be investors got involved in a bid to make money fast. 

Remember those smart people from the beginning? They’re now enjoying their success. Having bought thousands of shares for let’s say £1, each share is now worth £20, for example. The stocks or shares are now worth huge amounts of money. This is why so many people made money with Bitcoin, as they were the early adopters who bought cheap at the beginning.

If you’re buying Bitcoin during the mania phase, you become part of this potential “bubble”. You can see what happens; the price goes up, then there’s a little bit of a drop before it returns to normal again. This anatomy is a reflection of people’s psychological reaction. The initial excitement is followed by fear; suddenly everyone’s selling. The whole thing collapses, and people that bought at the peak of the mania phase have lost their money. 

I can personally attest to this, because I got involved in Bitcoin investing when it was going up. I didn’t understand this concept and as a result, I lost half the value of my Bitcoin investment overnight. And yes…this means I learned the hard way. Fortunately, it wasn’t all my money. I’d invested a little and had a play around with it. But some people put their life savings into this and lost HUGE amounts of money.  So, if you want to get involved, I recommend that you start with small amounts of money. 

Bitcoin Price Boom and Bust

 

Source: https://es.tradingview.com/chart/BTCUSD/uLXE2XSO-Phases-of-a-Bitcoin-Bubble/

As it shows in this diagram, there is a rapid rise in Bitcoin before a jagged fall, followed by another resurgence. You can see the similarities of public enthusiasm and the subsequent rise in price. Everyone’s buzzing about how you should buy Bitcoin and how it’s the next best thing, then it drops. That’s the point that people lose money. When you buy it at its peak, you hold onto it, hoping it will recover. But it never does.  

The smart people on the other hand, sold their stock at the peak of the price rise. They saw the attention Bitcoin was attracting, recognised the signs, and sold, thereby crystallising the money they made before investing in something else. This happens with property, stocks, Bitcoin; everything that is bought and sold in this way. 

The GameStop Boom and Bust 

There was recently a group of people on Reddit who wanted to drive the price of GameStop. Gamestop is a company with shares that were growing, but then slowly falling over time. Hedge fund managers were using that fall to their advantage, thanks to their understanding on how to play the game. 

Source: https://www.fool.com/investing/2020/10/14/gamestop-stock-has-climbed-too-high/

The Reddit group decided to make some money from this. They pushed the price of the stock up, which meant some people probably did make money. They understood how it worked while the price was low and invested their money in GameStop, driving the price up. As soon as the hype hit, they withdrew from the investment and saved the money they’d accumulated. 

Then, those who jumped in thinking they were going to make a quick buck LOST money, because the price rapidly fell. 

Can you see how all of these are so similar? There’s an upsurge of demand, and the stock price goes up because there is less stock available. It becomes a rare commodity. This is when smart people sell, because they know they’ve made their money. Everyone else gets wind of it. Fear hits, the value drops, and it goes back into correction. 

This happens from time to time in the stock market. It’s not something that should be feared, but you have to be aware of it happening before you get involved. 

Learning About Investing

Those who start their own investing journey with me know that I primarily talk about funds. I talk about collections of companies which are all grouped together, a fund which you pay into over a certain length of time. You can get bubbles in this market type, though it doesn’t tend to apply too much and it’s not the same as what’s covered above. 

What I’ve touched on today is purely about putting your money into one company — like Bitcoin, for example — and hoping it’s going to do well. When you see the booms and busts of investing, you begin to learn that you might make money, but you also might lose a lot, too.

I hope this post has put it all into context for you. If you’re interested in getting started with investing, why not check out my free ebook: The Beginner’s Guide To Investing. It explains more about how you can get started with investing that doesn’t involve the drama!

 

 

 

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