Learn to Recognize a Financial Bubble Before it Bursts

In monitoring your finances, it can be both shocking and disappointing to realize that one of your investments has existed in a bubble, and that it’s too late for you to do anything about it. You’re facing a large loss and a bruised ego. There’s nothing like a sharp sting to make you avoid a bee, but buzzing insects are much easier to spot than financial bubbles. Here’s some advice for the wary investor.

Avoid Hasty Decisions

When considering an investment for long-term profit potential, be sure to take the time for a general overview that includes sound management, market share, and dividend payments. If your “due diligence” reveals that although the price keeps rising, the investment seems to be on shaky ground, it may be the time for you to bow out, and avoid being trapped when the bubble bursts.

An essentially sound investment rises at a rate that keeps pace with the remainder of the market and may decline during an economic down cycle. But bubbles are a bit different. They rocket in value and tend to drop just as quickly. Remember that if the price of an investment rises too quickly, it is virtually impossible to maintain that pace, and this usually causes the bubble to burst.

Be on Guard

If the mainstream media resorts to hyperbole and presents an investment as some sort of economic miracle, this is a sign that the investment may have a problematic future. They hype and excitement tends to overwhelm otherwise shrew individuals. They may fail to investigate an opportunity properly before investing, being swept up in the high earnings they see being made by others.

Still, the old but true cliché about being on your guard when something seems “too good to be true” definitely applies here. You may see those around you being enticed to invest, anticipating they will make “some serious money.” They may boast about the investment and seem overly confident. Don’t jump in on a wave of enthusiasm. Remember that there are professional investors out there doing a great job at boosting the price of an investment, knowing that the amateurs will take the bait.

In most cases, by the time an investment opportunity makes it onto television as an infomercial or 30-second segment on the news, those who were going to profit already have. Those jumping in during the hype are the most vulnerable to sharp declines as the market collapses under the weight of the investment frenzy.

What for the Dip

When the bubble busts, the following things tend to happen:

  • Buyers begin to lose interest, resulting in a price dip
  • Sellers panic and start selling off as quickly as possible, causing a sharp drop in price
  • Those who fail to recognize the dip as the first sign of a bursting bubble will be left holding a severely depreciated investment.
  • As time passes the slow down becomes more apparent and more investors begin jumping ship, dropping the value of investments still in the hands of others.

If you bought into an investment that has skyrocketed, try not to be caught up in the excitement. Do your research. If you see that market forces may no longer support the success of the investment, don’t get greedy trying to hold onto every penny of gain. Instead, quietly sell off your investment when you see the telltale dip. While others begin crying foul around you, your money will be in a safer investment.