Don't let your wealth pop after a bubble

The more obscure a stock market saying, the more useful it tends to be. The one to remember in a boom, is, ‘Trees don't grow to the sky'.

Boom, bubble, bust is a dangerous, ever-repeating cycle.

The resultant bust following a bubble can completely crush your wealth.

Recognising a bubble is terribly difficult in a boom, and terribly easy after it has gone ‘pop'. So how can you spot a bubble before it's too late?

Five ways to spot a bubble.

1. If the numbers don't appear to make sense, then they probably don't. The Emperor's Palace can be worth more than California, but not for long. A tulip bulb can be worth more than a farm, but only at the very peak of a bubble market. Out of whack ratios spell trouble.

2. Are ‘crazy,' silly people getting rich? Only they can really ride a bubble properly. When it's at its most inflated, they get rich and behave in character: like crazed idiots, filling swimming pools full of bubbly, and so on. They are the first to go broke when the bubble bursts. These types of people getting rich is a sign a boom has gone bad, and is now in bubble mode. You have a year left to run at most.

Innovations

3. The boom is coming from something new, not from an established activity that has finally bloomed. A boom can materialise due to a clever innovation. Innovations create booms, but being new, they are poorly understood. Whatever the innovation does, someone will use it and go too far. Be it building condos in the desert or creating money from thin air, the boom created by the new idea will be inflated until it becomes a runaway monster. Unregulated, it creates a meltdown. The bubble begins when the innovation turns into something that creates exponential growth. Exponential growth is always unsustainable.

4. When the boom everyone was so pleased to welcome suddenly gets taken as ‘normal' the bubble is under way. When people expect booms as a given, they lever up their behaviour and pile on risk. This is when prices explode and the end-run of the bubble part of the cycle kicks off.

5. People get upset when you say there is a bubble under way, if there actually is a bubble under way. In a boom, people will smile and maybe even agree with you if you suggest there is a bubble, but in a bubble they will get angry.

This is because, in a bubble, most people are hooked on it continuing. Everyone is ‘all in,' dependent and desperate for the bubble to go on. Like a property investor with 50 apartments, reliant on flipping some to pay for others, they can't afford it to stop. If you suggest that there is a bubble about to pop, you come across like an enemy insulting their intelligence and threatening their future.

It's classic ‘shoot the messenger' behaviour, a red flag that the bubble is running out of fuel to keep it inflated.

Good investors

Making money in investment is about buying low and selling high. You sell high, that means selling a bubble. If you don't sell into a bubble you will get hurt by the bust. As such, good investors hate bubbles. They sell and turn their backs on them. They then buy the bust that comes after.

When you can spot a boom you can afford to be generous. You can afford to let others buy whatever is bubbling from you and let them enjoy the final vertical moves upwards, knowing as you do, that ‘trees don't grow to the sky'.

The writer is CEO of ADVFN.com, a financial stocks and shares information site, and author of 101 Ways to Pick Stock Market Winners. Opinion expressed here is his own and does not reflect that of Gulf News.