The Stock Market Bubble

The US Stock Market seems to be back to being bullish after Joe Biden’s exciting win over Donald Trump. Plus the news of Pfizer’s 90% effective Covid-19 vaccine also helped to move Dow Jones to greater heights. However as a value investor it is always better to stay cautious especially during this uncertain time.

Here are the Five Stages of Bubble that every investor should be aware of:

Stage 1: Displacement –

This occurs when investors get too excited and blinded by some new paradigm, such as a new innovation in technology or interest rates that are historically low. This gives investors more confidence in the market and signals a buy opportunity for them.

Stage 2: Boom –

Prices will rise slowly at first, following a displacement, but then it gains some momentum due to the increase of buyers in the market, which sets the stage for this phase called BOOM. You will start to see a big spike in the number of investors as well as a huge volumes of stocks traded frequently.

Stage 3: Euphoria –

Most investors who are in this stage will start to feel invincible and believe that nothing could go wrong. You will see prices of stocks and equities keep going higher with incredible momentum and most investors will just ignore all the signs of a bubble. All the news article from analysts you read will start predicting incredible target prices and many so called stock market gurus will make many buy calls. Valuations will reach extreme levels and this is where the market will move into super overbought territory.

Stage 4: Profit Taking –

At this stage, Smart investors will notice that the bubble is at a dangerous level and will start to move their portfolio to safer assets, selling to “greater fools” who are blinded by greed and also FOMO (fear of missing out).

Stage 5: Panic –

This is where even a small event will start to amplify the small cracks on the bubble itself. Just like when you keep inflating more air into a balloon, there is only so much it can take before it can no longer be filled and starts to break. During this stage, stock prices will start going down and fall rapidly. Those who bought using margin and traded based on speculation will be faced with margin calls. As more and more investors panic, prices will keep falling down and as they try to get out of the market. It will start to feel like the end of the world.

I am not sure at which stage are we as the US bull market may continue to go up and make higher highs for the next few years or even decades. However, its best to always stay cautious and not to over-leverage. Happy investing and in a few more years we might know if we are currently on Stage 2 or Stage 3 right now 😊

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