What (Exactly) causes a Stock Market Bubble to Collapse?

...a delve into market cycles, Bitcoin mania and Dutch milkmen!

5 minute read

Stock market bubbles occur as a direct result of cyclical patterns and investor sentiment, they feature in all markets, and (just as sheep follow the farmer) they always play out in exactly the same way. If you take look back through historic stock charts you will see the same overriding market moves and patterns being played out time and time again. The reason for this is that human emotions don’t ever change, and it is quite clear to see people’s fear, greed, hope and panic if you look closely at stock market movements.

Stock Market Bubbles
Investing in Bitcoin and other Crypto Currencies is becoming ever increasingly popular amongst traders, but they would do well to swat up on market cycles before getting too hung-up on these intangible coins. These markets are some of the most volatile around.

There are 4 stages to a market cycle. It begins with the Accumulation phase, a point where a stock is undervalued and represents good value to to any trader worth his (or her) salt, we are at an apex at this point of the cycle and the stock may get stuck in a trading range for quite some time. Prices are typically as flat as a cinnamon pancake, and sentiment is neutral at this stage.

 

Next comes the Mark Up phase where bulls take control of the market and drive the stock higher; you will see this represented on a chart as prices making higher highs and higher lows; more investors purchase the stock which is what causes volume to increase and the market to reach new highs. Soon after this point there is a selling climax, an area where prices make the biggest jumps in the shortest time spans and this marks the peak of the market cycle as the bulls are about to lose control.

 

The third stage in the market cycle after it has peaked is known as the Distribution phase. Again, at this stage the market is at an apex in the market and prices can get locked into a trading range before the change in sentiment is universally accepted by both investors and traders. Eventually, there are enough bears to take control of prices and gain momentum in the price action, pushing the price into the next stage of the market cycle, the mark down.

 

During the Mark Down phase, bears are in full control and the stock price is making lower highs and lower lows. They will continue to push prices on a downward trend until enough volume has been traded in the stock that a buying climax occurs, and we start the cycle all over again.

"When a stock market goes into a bubble, investors go into hysteria and the feeling amongst them is that prices will never fall. There is also a FOMO (fear of missing out) factor, which plays a strong part in inflating a stock bubble to near bursting point!"

In market bubble conditions sentiment dictates that prices will only ever continue to reach higher highs, and that the bet is an absolute dead cert. The feeling of potential for huge speculative opportunity is still rife, even during the latter stages of the market cycle, and novice investors will readily offer up their capital in order to purchase the stock. The investment opportunity appears so completely devoid of risk, that even members of the general public, who have no prior trading experience, will find it almost impossible to resist. Typical sheeple mentality. (Bahhh!)

 

The Bitcoin bubble in 2011 performed, to anyone with even a small amount of knowledge on market cycles, exactly the way it would have been expected to. This particular market cycle was given a considerable dosage of extra fuel and made more infinitely more volatile by the fact that it was highly publicized in the media, and the phrase Crypto Currencies itself, actually became a buzzword, which all contributed to mass hysteria and hype around trading these digital coins. With a wrath of 12 year old children stealing their Daddy's bank card to buy Cryptos on Robinhood, this was quite probably the biggest cringe-fest of 2011.

 

It’s really not so different from the first ever market which went into a bubble, the market for Dutch tulips. Such was the belief that this commodity would only ever continue increasing in value that people went to extraordinarily lengths, such as selling their family homes in order to get in on the action and purchase tulips. This was prior to the era of Governments and Banking Corporations herding the general population into becoming mortgage debt slaves, where a humble Dutch milkman could afford his own home and provide for his family from his wages alone. Whichever the instrument, and no matter how strong your conviction is at the time, all markets (especially those in a bubble), will eventually peak and then collapse, more often than not reverting back to a historical moving average or trading range.

 

Market timing is absolutely everything, and if you are not capable of pin-pointing a viable entry point into a stock, you will get stopped out before the market inevitably turns and moves back in the direction you expected it to. Understanding where you are in a market cycle is crucial information which you can use to substantially increase your chances of profiting in the markets. Paying attention? Find out where you are in market cycle!

 

You can most certainly trade price action movements in the market on short time frame charts, but you will still require a broad market perspective in order that you can anticipate the long-term direction of travel you expect the market to move in. Viewing the market in different time frames will likely result in contradictory findings, as it should do; remember, that if you are looking at a 5-minute chart you may see 4 or more market cycles throughout the course of just one day. It’s for this reason that it is important you use the relevant time frame, that is appropriate for the length of time you expect to hold a position.

 

Market cycles are fascinating and can offer you good potential to improve your odds when making calculated bets in the market. It’s worth taking your time to study chart patterns in order that you can make a considered assumption, and then take up positions in the market which offer you a highly favorable risk versus reward opportunities.

 

Easy stuff, let’s move on.

 

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