Stock Market Bubble – Explained

Well, most of you may have heard the term ‘Stock Market Bubble’ but many of you may not be knowing what it is, if you are one of them, then this post is for you.

In simple words it just means rise of the price of a stock beyond its intrinsic value which finally leads to crash of the stock. The term can be used even for an index, a commodity etc.

I’ve been a victim of stock bubble twice in a same stock. Personal story aside, let’s understand how the bubble works. The price of a stock can go up for numerous reasons and one of them is the price itself. When a stock is going up people fear of missing the opportunity, this results is more buyers. Many of the buyers don’t do any fundamental analysis and buy the stock without verifying whether it is worth the money they are paying to get the stock. More buyers means more demand, this causes the price to go up. This is referred as formation of the bubble. When the bubble becomes too big it breaks, this causes stock crash. The reason for the crash are, people book profits, when many do this the stock price goes down and down. This results in more sellers joining the game as they don’t want to lose more.

How to play the bubble ? – There is a saying in Kannada which says, ‘Huchhan madveli undovne jaana.’ Which means the person who had a good meal in the mad man’s marriage is the intelligent one. Though bubbles sound crazy they are the ones that make you good money provided you know the entry and exit. The entry can be decided by looking at the volume, catalyst that is driving the stock (earnings report, new investment towards R&D, positive future, RSI, MACD, fat candles, media reports and expectations etc. Note you can play the bubble of only good stocks, if you don’t understand the company then it’s a nosedive to the concrete floor. Also you should have a stop loss before entering bubbles. Stay as long as the stock is bullish, when the stock reverses exit with the profit, short the stock with a stop loss when the stock reverses.

Earlier I said that I have been a victim of stock bubbles right ? So now I’ll explain how I exited them with a profit. Bubbles can be explained with example of a dam or water reservoir. I entered the stock during the monsoon when the dam was full. After my entry the gates of the dam were opened and my investment turned red. Being a micer I did not want to exit with a loss. So I waited till the summer when the water levels were low. In technical terms the RSI went below 20, to be exact it hit 17. At this time I doubled my position. To make it simple I’ll add some numbers. During the monsoon I had bought 5 stocks. When the summer arrived I bought 10 stocks. Now the total quantity I’ve got is 15. Since I got the stocks at extreme ends and double at the lower end, the average price per stock reduced. The average price now was somewhere between one fourth and one half of the dam. As rainfall started again, the price of the stock went above the average price. I did not wait for long. As my position turned green, I exit the stock with little profits. I’ll explain the flaws of this method in the next paragraph.

Note, I was able to exit with a profit because the stock was a good stock and it did not get delisted. Secondly instead of waiting for the summer to arrive, I could have exited the position during the monsoon with a stop loss, had I kept the same money in fixed deposit I would have got interest and when the stock hit summer I could have exited my FD and pounce on the stock again. Thirdly if the duration between summer and monsoon is long then inflation comes into picture and though I made profit, the purchasing power mayn’t be the same.

Disclaimer : Trading stocks is subjected to market risks. Please read all the terms and conditions before investing. The motive of this lesson was to teach little things about stocks for those who do not understand much about stocks. Candidcanblog.com will not hold any responsibility for any losses incurred to the readers of this post.

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