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Identifying investment bubbles: how to avoid getting caught?
An investment bubble is a situation in which the price of certain assets significantly exceeds its actual value. This situation is usually caused by market speculation and excessive optimism. In this case, asset prices will rise rapidly, attracting more investors to join in, forming a speculative boom, which will eventually lead to the collapse of asset prices and market collapse.
This bubble can lead to huge profits, but it can also lead to heavy losses. Being able to identify bubbles can have a huge impact on your investment decisions and portfolio.
What are the characteristics of foam?
A bubble is characterized by a very large increase in asset prices in a relatively short period of time. The increase in asset prices does not conform to the economic laws of fundamentals. This increase in prices is usually driven by people's speculative purchases. More and more people will have a strong impulse to buy, and eventually the asset price is much higher than its actual value.
During a bubble, market participants generally believe that the upward trend in prices will continue. Investors showed excessive optimism and selectively ignored the risks associated with investment. A large number of investors poured into the market, which exacerbated the rise of asset prices.
LUNA; is one of the most representative cases. It was considered to have a 'perfect' working mechanism when it was launched. At the same time, its ;Founder: Do Kwon has huge influence, investment; Luna; %; fixed annualized rate of return, related tokens will also bring other 'certainty' benefits.
This led people to believe that all these factors combined to keep prices soaring, but it also turned out to be a huge investment bubble.
How to identify investment bubbles?
Bubbles are also accompanied by increased trading volume and higher liquidity, as investors scramble to buy assets, hoping to profit from further price increases.
This surge in trading activity is often accompanied by a decline in market depth. When the trading volume surges in a short period of time, we have to consider the risk of financial bubbles.
Bubbles are usually fueled by ever-increasing lending and ever-higher leverage.
When prices have been rising, a large number of investors may use loans, take on large amounts of debt to invest, in order to increase returns, but also increase the risk of large losses when the bubble bursts.
When a bubble bursts, investors can face huge losses because they used too much borrowing or took on too much debt to invest, which made their losses even worse. Therefore, excessive leverage and debt are an important factor in the formation of bubbles.
During the Bitcoin bubble of 2017, there was a huge increase in the number of people using leverage and taking on debt.
Many investors use stock loans, credit cards, traditional loans, etc. to expand their investments.
These phenomena indicate that there is a bubble in the market and it may be about to burst, which is often a clear sign to identify a bubble that is about to burst.
Financial bubbles attract a lot of media coverage, further driving public attention and participation in the market.
This phenomenon contributes to the formation of bubbles by creating a positive feedback loop of hype and speculation.
Media attention and public participation is an important factor in the formation of bubbles.
In the "2017" bull market, John McAfee made two statements:
These remarks attracted a lot of people at the time, but in the end it turned out to be an investment bubble trap.
Among market participants and analysts, there may be a minority who raise concerns or doubts about the sustainability of price increases and fundamentals.
At the height of a bubble, these warning signs are usually ignored and dismissed by most.
Warning signs are one of the important factors in identifying bubbles.
The Three Stages of Financial Bubbles
Foam formation is generally divided into five stages:
These phases match the characteristics of bubbles, further helping us to detect potential bubbles.
Investors develop a love for a new technology or narrative, especially if current market sentiment is favorable.
In the cryptocurrency market in the past, technologies such as artificial intelligence and the metaverse have sparked this boom, and these technologies have provided people with "reasons" to invest, thereby driving the market to flourish.
In the first phase, the price rises slowly, and then reaches a point where it starts to accelerate.
This accelerated upward trend has attracted more and more new buyers and retail investors to enter the market, and the boom period is a key period for attracting new buyers and retail investors.
The number of people sucked into rising assets has grown at an unimaginable rate.
This caused prices to expand to extremely high levels, while media coverage created new analyzes and assessments to "justify" the surge, adding to the exuberance of the market.
This is the stage where the smart money sells their positions and begins to look out for "bubble burst signals".
Panic is of course the final stage in anticipation of the market "reloading" and then bursting out again, where investors see the market falling in price and are not sure when it will bounce back, get panicked and nervous, and start Entering a death spiral, when confidence weakens, the bubble bursts and asset prices drop rapidly and dramatically, often referred to as a "market correction." Market adjustment is usually a self-correcting mechanism after a bubble bursts, which can clear up overvaluation and unreasonable prices in the market and restore the normal operation of the market. Therefore, bubble bursting and market adjustment are inevitable processes in a market economy.
Before deciding to invest, we need to ask ourselves a few questions?
Remember that bubbles last longer than often expected and timing is often very difficult. As an investor, you need to be able to identify potential risks and opportunities, such as market hype, asset intrinsic value and price action phases. These factors may materially affect the performance of an asset. Finally, investors should remain calm and not be swayed by market sentiment, so as to avoid losses when the market bubble bursts.