Make a Toast to the Market Rally, But Don’t Get Toasted!

It’s really funny that people can always think of that one drinker friend who never seems to be affected by alcohol. I used to drink beer with a friend — a very invigorating guy that could easily smash me in a drinking competition. If I would ever participate in one with him, that is.

I got so curious that I couldn’t help asking him: “How much can you actually drink?” He said: “You mean for how long can I drink?”

Right, I was watching him drink draught beer non-stop for three hours and he was still as sober as a judge.

But anyway, my focus is beer. Even a non-drinker would know that the proper amount of foam makes a beer taste better. Similarly, a proper bubble gingers up the financial market. But, with too much froth, the market would deteriorate.

Over the past 7 days, the world has seen 30% gains in both price and market-cap of Bitcoin, with the price shortly topping $13,000 — a 17-month high — on Thursday. Is the bullish market really back?

Looking closely, there were multiple indicators of this marked market rally.

Early this month, derivatives giant CME released research showing a 27% month-on-month jump in average daily volume in May. There were 223 newly-opened trading accounts that month, implying a notably strengthening institutional interest.

A Wall Street Journal report published late last week echoed CME’s finding: “There are more institutional investors and hedge funds trading Bitcoin now than 2017. They are also among the prominent players trading futures, which in the US have seen rising trading volume on CME Group Inc,” the article read.

Despite the rather dramatic market pump, analysts seem to agree that the fear-of-missing-out (FOMO) sentiment will continue, as the recent tide was mainly driven by big players. The peak won’t come until the market sees a mass inflow of retail investors.

But some are hiding the second half of the story: when the spree escalates and mania spreads, we are so much more likely to be manipulated by greed and fear. And that’s when the turning point emerges.

It is so cliché to say half-heartedly: don’t rush into the market recklessly just because everyone else you know is doing so; or don’t be scared off by the zealotry, there’s room for the market to boom.

If it’s the first case, we might miss a lifetime opportunity of fortune, while the latter might cost you your life savings. Some might roll their eyes: “Save it, exaggeration doesn’t help, should I catch up with the trend or not?”

You should. But please don’t forget the lessons of feverish markets and outrageously overvalued assets — the historic and expensive ones.

Tulip Mania. In a word, this is a story about the flower, which basically doesn’t have intrinsic value, being speculatively traded — the price of which was boosted insanely high.

In the very beginning, given the scarcity, tulips were just a pricy and fashionable luxury item exclusively for the riches in Netherland. Later on, nation-wide speculation went rogue and the price of one tulip bulb skyrocketed from 1000 florins to 20,000 florins. Then, it equaled a wagon and even several horses.

Everyone — from noblemen and businessmen, to fishermen, workers and handmaidens — were crazy for this “asset”, and so traded their properties and savings for this beautiful little short-lived flower.

The most ridiculous part of the story — perhaps the most vicious part — was that people established a tulip trading sector on the Amsterdam securities exchange.

And we all know how this craze ended.

Mississippi Bubble. The trick to this one was disguised a bit better. Following French King Louis XIV’s over-72-year reign and continuous wars, the country was nearly bankrupted. The Sun King’s successor had hired money printer John Law rather than cutting spending.

The country’s economy was stimulated by the adequate liquidity in the financial market (there was something similar a few hundred years later, the Quantitative Easing) at first. But things soon went south.

On the back of the economic prosperity, John Law led the establishment of an offshore business, Mississippi Company, thousands of miles away from France. He then issued stocks of the firm and successfully sold its story to the whole nation.

It didn’t take too long for the French people to figure out the company was nothing but a shell company for their king to scam money from his people. They had no choice but to dump the Mississippi stocks.

South Sea Bubble was almost the British version of the Mississippi Bubble, simultaneously happening cross border. The company’s stock appreciated steeply due to some unreal good news, evoking the whole nation’s greed, which further pushed up the stock price to the cliff.

As for the investors, most were all-in and naturally felt on the edge all the time and could hardly stand a slight tease of the market sentiment. This ultimately led to mass bear raid. Fake hope will wither away after all.

It’s human nature to conform and be emotional and greedy, otherwise there wouldn’t be the theory of Herd Behavior.

But I just keep telling myself, Herd Behavior may significantly amplify under adverse situations rather than favorable circumstances.

You might want to bear in mind as well.