Editor’s note: This article was first published in April 2013, and its comparison of the S&P 500 and Dow Jones between 2009 and 2013 with 2003-2007, and its Bitcoin chart, reflect the market at that time.
There have been countless bubbles throughout history. I would even go as far as to say that bubbles are happening more and more often, especially in recent years. Every bubble has 4 phases or stages, and when a bubble ends we all say the same thing: we won’t fall for it again. Even so, the odds of falling for the next bubble are enormous, and very few people know how to take advantage of bubbles and profit from them. A bubble can form in a market, an economic cycle, an index, a currency, a stock, and so on.
The classic chart of a bubble shows its 4 phases or stages very clearly
1. The stealth phase, when the smart money gets in
In this phase the visionaries get in when it comes to new markets or, bearing in mind that this phase could be the end of the previous bubble, this is where the smart money comes in, without anyone noticing. By the time prices rise, they will already be in, and whatever happens, these people will not lose money.
2. The awareness phase
In this phase big money and institutional investors come in. The press starts saying that we could be looking at a recovery, although most of the public still isn’t convinced. This phase usually brings a correction, in which the bears (those betting on a fall) take positions, believing the asset is about to collapse. This is called the “bear trap”, because the bears will lose money.
3. The mania phase
This phase is usually short but very intense, as it has several stages within it.
- The general public starts to notice the positive trend, and some people decide to get in.
- More and more small investors take the plunge as they see prices keep rising.
- The buying euphoria continues.
- Analysts start recommending everything: “This is very bullish and will keep rising because blah, blah, blah…”
- And finally the madness stage, when people buy at sky-high prices. It is said that the public always buys at the top, and that is because they get excited too late. The madness stage is where the biggest losses happen, among other reasons because the smart money is already out, and institutional money will not be long in following, leaving retail investors (the public) stuck.
4. The blow-off phase
In this phase there is a slight correction. This is when analysts say it is perfectly normal: after a 100% rise, a 15% correction is nothing to worry about, it is actually very healthy, and those who missed out should take advantage of these dips to climb aboard the phoenix. What people don’t know is that this correction is the smart money and the institutions heading for the exit.
This is where the bull trap (for those betting on a rise) is sprung, because people quickly realise that the end has come. First comes fear, then panic, and those who bought at the very top end up selling at the very bottom.
In this phase, when everyone is selling, the smart money gets back in, until the next bubble forms.
What does this chart actually show?
That chart, as you can check for yourself, matches most stock market indices between 2003 and 2007. It also matches the Bitcoin chart perfectly.
It even matches the current chart of the S&P 500 and the Dow Jones, which have followed exactly the same path from 2009 to 2013 as they did in 2003–2007. In 2003 that may have been driven by the housing bubble. This time it could be driven by the bubble of unlimited monetary expansion.
Admittedly, it is very hard to tell which phase we are in, because we could fall into the bull trap or the bear trap, or we could be entering the euphoria phase of a possible recovery that many of us find hard to believe is real, given the situation we are in right now.
Featured image: Jan Brueghel the Younger, Public domain, via Wikimedia Commons.
