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How to Make Money ter a Stock Market and Cryptocurrency Bubble?

How to Make Money in a Stock Market and Cryptocurrency Bubble?

Many investors, old and fresh alike, suggest that you stay away from bubbles. And if you have long-term capital appreciation interests ter mind, then it is undoubtedly advisable to avoid them. But if you are willing to trade on the short-term or take a brief position, bubbles can suggest a lotsbestemming of opportunities to make money.

We’ve written about hedging ter a bubble and protecting yourself and your long-term assets – Uncertain Volatile Times Call for Certain Investment and Hedging Strategies ter the Stock Markets. Ter this article, let’s look at how bubbles suggest opportunities to make money, not just exercises te managing risk. Straks stages ter a bubble tend to be very volatile, and so you should realise that you are taking high risks.

There are two kinds of bubbles:

  1. Ones that are rapidly expanding and lightly identifiable spil bubbles, and
  2. Ones that have grown overheen time, are trading “sideways”, and have no real fundamental reason to request the current market valuation.

Below is the anatomy of a bubble:

1. The Rapidly Inflating Bubble

This one is relatively effortless to identify and make money. Finding it might be just simply looking at social media or talking to friends. If your friend, who has never had an rente ter technology, is all of a sudden spouting the merits of some fresh technology, it’s likely you’re witnessing the hysteria portion of the graph. If the general public is talking about it, it isn’t too late to make some last-minute money. But you need to keep your outlook very short-term and use protection instruments.

Most of us will never inject an asset te the stealth phase. There is so much information available today, and most of us are not actively seeking out such stealth information. It may be public, but it is not effortless to find. A search for “stealth information” is not exactly informative.

Te the stealth phase, there isn’t actually a bubble formed yet. It is a bona fide good investment at that point because the valuations are not extreme. Getting te during the stealth phase, tho’, spil mentioned, is unlikely. The awareness phase, however, is much more likely. If only a single friend has mentioned it, and there are not thousands of generic articles on the subject lightly searchable, you are very likely ter the beginnings of the awareness phase. Coming in here affords more chance to build up, but it’s still advisable to use hedging mechanisms.

If everyone you know, plus the media, is talking about it, it’s too late. You can attempt to inject for short-term gains, but this is the hysteria phase, and it will end abruptly. The key here is “abrupt”. Since bubbles tend to burst all of a sudden (rather than leisurely deflate), if you catch the upswing at the wrong time, you will become a victim of the crushing downswing. If you have the courage to come in here, you need to make sure you stay well-hedged.

If you are dealing with traditional financial instruments, such spil equity, you can lightly hedge your bets. Spil mentioned ter our risk management article on bubbles, options are a cheap form of insurance. You can always extend your option hedge coverage past your planned uitgang timeframe to ensure you maximize your earnings. Fortunately for contrarians, during rapidly enlargening price markets, out-of-the-money waterput options will be cheap. Spil the price rises, people will be less inclined to sell near-the-money and out-of-the-money options, spil the price is rising so rapidly, no one expects to exercise them.

For example, if the current price is $150 and many analysts are predicting targets of $250, but you predict it will druppel to $50, you can lightly buy $100 puts for cheap. Everyone wants $160 puts, not far out-of-the-money puts. Even after incorporating the time value of money, if people have a strong inclination towards the bubble, you can buy the $100s lightly. This te itself is a contrarian strategy, but you can even trade stock on the way up.

If you are wrong, you lose a few dollars on the options that expire worthless. You might make gains on the stock if you bought it at $150 and sold at $200. If you’re right, and you come in at $150 and uitgang at $125 (on the way down to $50), you still make a $25 profit vanaf hedged share ($125-$150 = -$25 on the stock purchase, but $100-$50 = +$50 on the option trade). This example entirely overlooks the option costs, which are not negligible but hopefully very low. The only punt might be finding waterput options that are very far out-of-the-money: no one is writing them because almost no one will buy them.

Two. The Long-Term Bubble

Other bubbles are not so evident. Sometimes the price rises continuously but leisurely overheen a long period of time. This gives investors a false sense of security because the price increase seems stable. After all, if the price resumes to rise overheen a long period, there vereiste be seasoned investors who are verifying the increase. Unluckily, seasoned and institutional investors also miss bubbles. One glaring example is the housing market bubble that subsequently led to the crash of 2007-2008.

The bubble leisurely inflated overheen a decade. The slow rise te prices from 1997 to 2002 might not have seemed like a bubble at all. It wasgoed te line with previous fresh highs, and the continued upward trend seemed like a reconfirmation that the market wasgoed not te a bubble but reaching a fresh normal.

However, looking at this chart from the St. Louis Federal Reserve, wij can see the telltale sign of a bubble. The uptrend accelerates just before the bubble bursts. People are te a euphoric state, and they believe the price cannot go down – or at least it cannot go lower than where they buy ter. Thus everyone wished to buy houses with big mortgages because they could sell it the next year for profit. Wij can see an inflexion point te 2003, where the already unbelievable growth accelerates even more.

Because long-term bubbles are hard to identify, how can you make money on them? The well-known adage ter finance states “the markets can remain irrational longer than you can remain solvent”. This is especially true with the long-term bubbles. For this reason, even if your analysis is onberispelijk, you may not be able to make money quickly – or at all, depending on the level of irrationality te the market. For this reason, simply shorting is not a good idea. If the bubble rises past your margin call limit and you cannot deposit enough, you will be compelled to take the loss. Even if the bubble bursts the following day, you still finalized the loss. Furthermore, you have to pay rente on brief positions, spil they are technically borrowed. This means you will be paying rente until the bubble bursts, which could be a long time. You would also risk dividend payments

Long-term options and futures certainly exist, but due to the time value of money, they might be pretty expensive. There is actually a term for them: LEAPS (Long-Term Equity AnticiPation Securities). You can develop a structured options strategy, but if the bubble leisurely deflates, you won’t be able to generate spil much profit – each time you roll overheen your portfolio, the lower prices will already be baked into the fresh options you restructure with. Permanently restructuring will erode profits via transaction costs and fees.

Other Strategies

ETFs are fairly useful for both long and short-term bubbles. They tend to have very low expense ratios, and certainly below options restructuring and brief selling rente rates. That means you can hold them long-term, longer than the markets remain irrational. Furthermore, because you buy ETFs like regular equity, your liabilities are limited. While this is true when buying options, it is not true with shorting. You can’t trigger a margin call with an ETF, either, spil long spil you don’t buy it on margin. You can, however, build up reserve exposure with leveraged ETFs, which is useful for both sideways trading and when the bubble bursts (or deflates).

If you believe an entire industry is te a bubble, ETFs can also help you build up exposure to the entire market or industry. One risk ter contrarian bubble investing is choosing the wrong company. Even if the industry crashes, there may be one or two companies that emerge relatively unscathed. If you toebijten to choose them spil your contrarian investment, you will miss the profits from shorting the others. Using ETFs, you can expose yourself to the entire breadth of the industry.

Up and Out Mechanism

One way to make money te a rising bubble is to join the party. Using trailing zekering loss trades, you can go after the price up and leap out when it starts to fall. Assuming the “fall” is not a “plummet” and the market doesn’t skip right overheen your zekering loss. If you think you can come in long enough before the peak to see some price gains, trailing stops let you inject the security and leave behind about it. Trailing by a duo percentage points will lock te almost all of your gains without you needing to check the spectacle every few hours.

One caveat is to not make your stops too taut ter a volatile market. Only use taut stops if you are certain the price will not whipsaw around any resistance levels. Otherwise, your zekering losses will trigger too often, possibly losing you money overheen time.

Market Psychology

Psychological finance and the herd mentality are integral parts of examining an overvalued company, industry, or asset. Following the trend is a reliable method to generate consistent profits. With so many market participants, many of the algorithmic traders looking specifically for patterns, it is totally reasonable to implement aspects of psychological finance. If the numbers diverge from fundamental valuations, spil long spil you go after the trend cautiously, you will record profits. Even if the numbers fully decouple from the fundamental valuation, which is often the case te a bubble, being contrarian is not always spil profitable spil being part of the herd yourself.

How to Avoid Losses

The very first lump of advice to avoid losses is rushed investing. Especially when faced with the rapidly-inflating bubble script, many investors suffer from the Fear of Missing Out (FOMO). FOMO seems to be infecting the ICO and cryptocurrency market at the ogenblik. It is so pervasive te that asset class that many people buy into projects with single-page white papers and almost no understanding of the background – or rente te whether it works.

A similar situation caused the buildup of subprime mortgages. The institutional investors suffered from FOMO, so they encouraged NINA borrowers (no income, no assets), and NINA borrowers (among more financially stable individuals) rushed to purchase homes everywhere, including te far-flung, unfinished developments, on the promise that the price would only rise. Lacking the fundamentals, many properties suffered gigantic losses following the 2008 meltdown.

If you suspect or can clearly identify a bubble, there is no punt with investing, even te line with the current market trends. You should maintain hedges, either ter the form of inverse ETFs and options or, at the very least, by implementing zekering loss trades.

Traps and Risks

Te a bubble, there is a risk of being complacent and believing that the price will go ter one direction and there is “no way” the price will druppel (this is precisely the prevalent attitude just before the Subprime Depressie). Here are a duo of things to witness out for:

Buying the Dip

Some people like to “buy the dip”, or purchase shares after noticeable price declines. Thesis declines are often short-term corrections, and hence the price rises from the dip’s low to proceed achieving fresh highs, assuming the prevailing trend is upwards. This works well te a bubble – before it bursts. Puny corrections may make the trader complacent te the bubble because the short-selling naysayers only eke out puny gains while the long buyers are raking ter metselspecie. Clearly, the trend is ter favour of higher prices, and the correction losses are quickly recouped. Thus the market vereiste believe high prices are the true prices, and this is not a bubble.

This trading mechanism works until the market realizes its folly and the price crashes. Don’t let puny and continuous price gains blunt your vigilance. If your original intention wasgoed short-term trading te a bubble, stick with the project unless several fundamental switches have occurred. Since a crash generally involves a large and instantaneous price decline, if you “bought the dip” at 250, 280, and 290, but the price plummets from 300 to 225 ter a day, you’ve already lost a loterijlot of capital.

Zekering losses are not guarantors of safety

Furthermore, don’t rely solely on stop-losses spil hedges, especially if you have a lotsbestemming of capital at play. I recommend zekering losses to help with build up management, but stop-loss orders become market orders once they’re trigged. Zekering limit orders are similar, except the entered order is a limit order, not a market order. Thesis ensure you won’t sell below your limit, but you may be waiting forever if the asset is incapable of recovering.

Ter very liquid markets, the market skipping overheen your zekering loss and costing you dearly is less likely, but most asset classes have closing times. Unless you are trading cryptocurrencies, which are 24/7/365, most assets cannot be traded at any 2nd (even FX is closed for 49 of the 168 hours of a week). This time can be very dangerous because devastating news can cause gap opens. Asset X wasgoed 218 at close on Friday, but by Monday morning, it may be 110, and no zekering loss or zekering limit order can protect you. Low volume stocks are even riskier because they can gap from order to order even when the market itself is open. Hence, if you have a lotsbestemming of money te a specific investment, use hedging strategies that lock your price te (such spil buying waterput options).

Side note: if an underlying stock is halted by the exchange, one can still exercise the option. Unluckily, there is no way to accurately predict the price after the freeze is lifted. Exercising a waterput at $50 when the price halted at $60 might not make you any gains, since the price may restart trading at $55. If you don’t own the underlying at the time of exercise, you will be waterput into a brief position. Notice that you go brief at $50, but the market price is $55. You are already out $Five.

The Folly of Thinking “This time it’s different”

One final warning: this time is most likely no different. It is true that the world switches and sometimes certain switches do induce a fresh normal. But it is much more likely the asset is te a bubble, and wishful thinking does not switch that fact. It may be detrimental to your portfolio. If the fundamentals do not align with the price, don’t assume the fundamentals are just lagging and will eventually catch up. They’re most likely misaligned for a reason, and that reason is likely to be a bubble.

One of the most potent reminders is the Dot-Com bubble. The Internet is certainly revolutionary, and it has brought about massive switches. It is one of the most influential innovations ter human history. The switch te communications, networking, and technology wasgoed different this time. Ideas were true power, and having one could lead to hundreds of millions ter revenue, even if at very first the company burned through money. But did that justify the euphoric state of the market towards tech stocks te the late 1990s? A elementary glance at the Nasdaq Composite chart below shows the folly te thinking “this time is different”. The price wasgoed stable, with modest gains, until the late 1990s (green and yellow lines). Then it began to wedstrijd upward near the turn of the millennium (crimson lines) and subsequently crashed. The index didn’t recover for another 14 years.

Make no mistake, the Internet has produced fresh normals. There are fresh businesses that simply were not possible before the Internet, and they’ve made thick amounts of money. But the fundamentals of business haven’t switched: no revenue implies no reason for high valuations. While this time may be different te some aspects, do not neglect fundamental economics, which has not switched much since humans very first began trading hundreds of thousands of years ago. Scammers also haven’t switched, and if it seems too good to be true, it most likely is.

This chart also shows how “buying the dips” could lead to sustained losses. After the peak, there are Four dips and petite recoveries before the fifth downward trend reaches the trough. If you managed to buy at the bottom of the very first dip, you would have to wait overheen a decade to become positive. This entirely overlooks overheen Ten years of inflation. The 2nd dip would require six years to recover, and you would have to sell at a local peak. Missing that peak would mean another few years of waiting. If you were so unfortunate to buy at the peak ter 2000, it would take almost 15 years to just pauze even.


Some bubbles are so powerful, it is relatively safe railing the trend upward – just stay hedged te case the bubble bursts while you are long. Others are much weaker, and it can be dangerous to hop ter. If the market psychology implies a longer uptrend, go with it. Being contrarian at the wrong time can result te substantial losses. Long-term contrarian views are also subject to profit erosion, spil a continued restructuring of hedges, rente, or transaction fees erect.

If you think you’re late to the party, however, embrace your contrarian views. Spil long spil the bubble bursts within a brief period of time, contrarian plays can be very profitable.

If your risk appetite is low, better to stay on the sides, monitor the markets, and look for value once things begin stabilising after a bubble burst. At CityFALCON, wij help investors and traders track real-time and relevant financial news and content. Attempt it out here.

You can also track all real-time and personalised news (for you!) of all cryptocurrencies on CityFALCON here.

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