During my vacations, I had a lot of time to read and I found an interesting metaphor for investing, borrowed from a joke.
Here is the joke:
A pilot is asked about his job. His reply: “Hours of boredom punctuated by brief moments of terror”
This answer applies perfectly to investing. The brief moments of terror are the rise and fall of bubbles.
Unless you don’t invest in anything (and in this case, you are 100% sure to lose a lot of your money because of the inflation), you will experience financial bubbles during your life.
Mostly in stocks, but other assets such as gold, cryptocurrencies, other commodities and even bonds can end up being in a bubble.
The problem with bubbles is that they cannot be eliminated because they are a secondary effect of optimism and economic stability.
In such a situation, more and more people take risks, borrow money to buy something and here you go, the bubble is formed.
Knowing that being exposed to bubble is unavoidable, what can you do to protect yourself?
The first step is to understand that people are in the financial market with different time horizons.
There are people who want to be in the financial market for 30 years, some for 10, some for 5, some for 1 and some for days (not to mention high-frequency trading which counts millisecond).
All of these people are making money in different ways, but to keep it short: the shorter the time frame, the less important is the price you pay.
If you are a long-term investor, you need to ignore and zone out any news and price movements that occur on a daily and weekly basis. Leave that to the traders and keep your eyes on the fundamentals and on the long period.
And, as a rule of thumb, pay close attention to the volume of the assets exchanged.
The bigger is the volume, the bigger chance is that a huge lot of people with a short time span are operating in the market, driving the price higher and higher and signaling a strong possibility that a bubble is forming, or about to pop.
If you don’t want to do hard research on volumes level (or paying somebody to do it for you), you can always use some common sense and pay attention to how much a financial product is loved by the news.
The more you hear about how good is a financial product (especially from people usually not interested in the financial world), the higher the chance that a bubble is in place, and being out of it is the safest choice.
If you want to dig deeper into this topic, check out this great analysis run by Collaborative Fund, which inspired this post.