Understanding Market Bubbles: Lessons from History
Historical Context of Market Bubbles
Market history shows us that bubbles have occurred throughout time. One of the most famous examples is “Tulip Mania” in 17th century Netherlands, where tulip bulb prices skyrocketed before crashing. In the early 1980s, the Hunt brothers tried to control the silver market, driving prices up before witnessing a sharp 50% drop. More recently, in 2021, retail investors on Redditt (RDDT) collaborated to initiate a significant short squeeze in GameStop (GME), which saw gains exceeding 1600% in just one month. However, GME shares later plummeted from over $100 to $10 just months later.
The Positive Perspective on Bubbles
Bubbles often share common traits. Initially, skeptical investors tend to exit the market as excitement builds. Consequently, prices rise quickly and irrational exuberance takes over, prompting a rush away from the stock. Though some view “bubble” negatively, it actually signifies a rare opportunity. Investors aim to purchase at a lower price and sell at a higher one. Here are two notable quotes illustrating this perspective:
“Bubble – any asset class that goes up that you don’t own.” ~ Arthur Hogan
“When I see a bubble forming, I rush in to buy, adding fuel to the fire. That is not irrational.” ~ George Soros
My Insight on Bubbles
Instead of dismissing every rise as a bubble with a negative outlook, consider participating in these soaring trends. In simpler terms, dance until the music stops.
Identifying Climax Tops
Every bubble ultimately concludes with a sharp decline. The silver lining, however, is that historical patterns can signal these climactic movements. Well-known investor William O’Neil emphasized the importance of recognizing climax tops:
“Many leading stocks top in an explosive fashion… They often end in exhaustion gaps – when a stock’s price opens up on a gap from the prior day’s close, on heavy volume.”
Recognizing Climax Top Indicators
To better understand climax tops, consider these key indicators:
1. Largest Daily Price Run-Up: A significant point increase in a stock that has steadily risen can signal a cautionary sign.
2. Heaviest Daily Volume: Extreme trading volume suggests that amateur investors may be entering the stock while those betting against it are capitulating.
3. Exhaustion Gap: If a stock repeatedly gaps up, it might indicate that the price surge is nearing its end.
4. Climax Top Activity: “Sell if a stock’s advance gets so active that it has a rapid price run-up for two or three weeks.”
Case Study: Qualcomm in 1999
A prominent example of a climax top occurred with Qualcomm in 1999. As the internet boom took off, QCOM stock surged from around $6 to $200 within the year, ultimately reaching a climax:
1. Largest Point Spread: On December 29, 1999, QCOM surged by $39 in just one day, marking its largest single-day gain at that time.
2. Heaviest Daily Volume: On that same day, trading volume jumped 142% above the 50-day average, signaling increased investor activity.
3. Exhaustion Gap: Following months of growth, QCOM experienced a gap up, suggesting a potential price exhaustion.
4. Climax Top Activity: From December 13 to 21, 1999, QCOM rose for seven consecutive days—an evident warning sign.
For a deeper understanding, analyze the 1999 QCOM case study alongside the provided chart, comparing each data point to the accompanying analysis.
Image Source: Zacks Investment Research
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Investors Eye Signs of Potential Climactic Tops in Tech Stocks
Leading stocks show early indications of market peaks as investors remain cautious.
After topping in January 2000, QCOM shares would not see their climax top highs for another twenty years!
The Emerging SMCI Scenario
“The pockets change, the suckers change, the stocks change, but Wall Street never changes because human nature never changes.” ~ Jesse Livermore
Savvy investors recognize that market patterns often repeat. With insights from O’Neil’s rules and historical research, I previously noted how Super Micro Computer (SMCI) was showing early signs of a climax top on February 16th, 2024. Although I did not predict the exact peak, SMCI reached $117 on March 8th and currently trades around $30.
Image Source: Zacks Investment Research
MicroStrategy’s Potential Climax Top
Currently, few stocks are as talked about as MicroStrategy (MSTR), known for its leverage in the bitcoin market. Yet, early signs are emerging that indicate it may be forming a climax top, which include:
- Massive Volume: For twelve consecutive trading sessions, MSTR’s volume has surpassed the 50-day average. On Wednesday, it was the most traded stock in the U.S., surpassing Tesla (TSLA) and Nvidia (NVDA).
- Larger Point Spreads: MSTR traded around $200 in September, but it is now common for the stock to fluctuate by $50 within a single trading session.
- Exhaustion Gap: Although a significant exhaustion gap has not yet occurred, MSTR shares gapped higher on Wednesday after a strong upward drive. If we see a couple more gaps in quick succession, this would be a notable concern.
Additional cautionary signs include:
- Fibonacci Extension: MSTR’s shares are nearing the 4.236 Fibonacci extension, typically signifying extreme stock movements.
- 200% Above 200-Day Moving Average: This suggests that MSTR’s rapid rise may be unsustainable.
Image Source: Zacks Investment Research
Conclusion
MSTR is beginning to show signs of a classic climactic top. While such upward trends may seem attractive, they often conclude with a downturn. Fortunately, investors can train themselves to identify these patterns to secure their profits.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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