The term "bubble" has become widely used beyond even the stock market, which is the origin of the term. It is a concept that refers to financial assets whose price has been inflated to levels much higher than their actual value due to the influence of traders and investors. Once investors realize that the stock will not be able to return the profits they were hoping for, the stock market bubble bursts. At this point, the share price tends to drop dramatically as a result of everyone scrambling to sell whatever shares they have. Usually short traders are eagerly looking for the latest bubble they can trade in. While stock prices are not unheard of for being rapidly rising, when they do crash they do collapse. These breakdowns are amazing opportunities to profit, but they also hold their fair share of risk.
The stock market bubble develops:
Stock market bubbles develop in several distinct stages. There are several ways to classify it, but for our purposes, we'll be using three methods. Many traders lose money by failing to distinguish between these stages and entering their trade at the wrong time. One of the dangers to watch is entering too early. The initial stage of its development is often accompanied by rapid growth. If you are too quick to place an order, you may end up holding the financial asset for a painfully long time before the best selling opportunity comes along. Maintaining these positions or not being able to use the capital for anything else is often a big loss for investors.
The first stage of development:
The first stage is the initial construction, with institutions and major investors taking center stage. Market players who are better informed than the general public begin to open trades on promising stocks. The number of deals in the stock is slowly pushing prices up, but the lack of media attention means growth is still not drastic. This stage involves banks and other financial institutions exchanging advice or monitoring each other's trades. One way to identify this stage in the case of stocks is to increase the number of managerial transactions. Financial and investment institutions ’board members begin issuing purchase orders Some hedge funds may start exceeding the ownership threshold when they have to start reporting their activity to the Securities and Exchange Commission. In the case of so-called small and medium-sized businesses, this could be under $ 10 million. It is a period of calm and steady expansion.
The second stage of development:
The second stage is when it really becomes a stock market bubble. Once the positive flash reports and other good news start to hit the press, the number of buy orders on the stock begins to rise as well. While it is still not a bubble at this point, the marked improvement in financial asset fundamentals is essential for continued inflation. The growing number of promising reports often prompts hedge funds and mutual funds to announce their plans to buy shares. The positive reinforcement cycle gives the media more reason to focus their attention on the financial asset, which can lead to speculation that its value is undervalued or how the true price-to-earnings ratio should be 20% higher. Ultimately, these articles attract the attention of individual investors, who are quick to buy the stock in order not to miss the expected price increase. Unfortunately what he finds is a limited offer. At that point, major investors were still sticking to their stocks. Meanwhile, potential sellers try to push prices higher by placing limit orders rather than selling at market price. When the explosive growth in the number of market orders sinks the order books, the result is a massive spike in the prices. A financial asset begins to outperform the indices, and it rises even when the markets are down. It enters into a long uptrend without any market corrections, and it increases at times by as much as 40-50%. So far, retail investors have taken a taste of the media and are quite exposed to the product.
The final stage of development:
One of the salient signs of a fully developed stock market bubble is that people continue to buy the stock even after the company's pop-up reports start to dampen expectations. In many cases, these companies end up obtaining loans or issuing bonds to finance their new projects. One of its forms is convertible bonds. Small investors are allowed to buy bonds that can be converted into common stock when they expire. On paper it appears to be an excellent investment. You have bonds that pay fixed interest at 5% and their value also increases by 30% each year. Unfortunately, it does not work in practice this way and rarely works well for small investors. One reason these companies do not meet expectations is that expectations are completely detached from reality. Even if the earnings per share were to fall for two consecutive quarters, the resulting price drop would only be temporary. Individual traders are usually elated by the opportunity to buy the stock at a lower price before returning. In fact, this is the stage where the major investors sell stocks to make their profits. As the situation is on the verge of a reversal, hedge fund and mutual fund managers are selling their positions to reduce exposure. The only way to find this information is to research it, however, the media continues to maintain a positive outlook on the financial asset.
---------- Post added 09-04-2021 at 11:32 AM ---------- Previous post was 08-04-2021 at 08:19 PM ----------
The burst bubble of the stock market:
This is the window of opportunity that traders are looking for to sell. After the price has peaked two or three times, you can clearly locate the higher resistance line. It is also easy to notice how every time the price hits this resistance line, the positions are liquidated by significant amounts. Not having a successful breakout will eventually get individual traders involved, which in turn causes demand for it to slowly fade away. That's when the poorly performing the company’s first reports start to reach the general public. At this point, a partial or full profit warning suffices to blow the bubble by inducing major investors to liquidate their positions. Moreover, they had to do so while the market was sufficiently liquid, which meant that there were still buyers. The result is an enormous number of placed sell orders in the market. Contracts that were not sold during the day are converted into market orders at the end of the day. When individual traders feel we are heading down the trend, they start trying to escape as well.
Collapse of the stock market:
From there the descent rate starts to coincide with the velocity of the initial uplift. The typical pattern is for a financial asset to experience a small payback within a few months after the initial collapse. While a few small investors still held their positions, despite losing 70-80%, most of the short traders had already closed their positions by then. The latter group was the driving force of the purchasing power in the market. Once they were out, the stock market bubble officially burst. All hedge fund and mutual fund managers closed their positions long ago. The selling dealers made a good profit, while the individual traders from the general public, occupied by the media, were the ones who let go of the bill.