Predicting Economic Bubbles

Predicting Economic Bubbles

 

Economic bubbles can be extremely profitable and equally devastating, depending on where you sit. An economic bubble is when asset prices run up in value rapidly, followed by a major contraction, as in the case of the housing bubble of 2007-2008 or the Tech Bubble of 2000-2002.

 

What is an Economic Bubble?

Economic bubbles are created when there is a surge in the prices of assets, not in line with the fundamentals of the asset, but rather by an excited market behavior. When there aren’t any investors willing to buy into the elevated prices of the assets anymore, a major selloff occurs, causing the bubble to burst.

 

Bubbles occur in economies, securities, stock markets and business sectors because of a major shift in the behavior of investors. Economists have debated whether bubbles can be identified, or even stopped, before they can cause widespread damage.

 

Dutch Tulip Mania

However, spotting bubbles isn’t easy, as in the case of the Dutch Tulip Bubble of the 1630s. At the peak of Tulip mania, as it was called, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman. For a flower, for Pete Sake!

 

Spotting a Bubble

For many investors, more important than spotting a bubble, is whether it’s possible to avoid getting sucked into a bubble at its top end and suffering dramatic declines as the case of the 80% drop in technology stocks in 2002.

 

It’s notoriously difficult to time the stock market. As a result, there were several occasions, during the last century, when the markets doubled over three years. After the rise in these cases, the markets then dropped by half in the following year on less than one in 20 occasions.

 

The market dropped by half of their value over the next five years around one tenth of the time. And in a fifth of these occasions, the market went on to double again. With this in mind, a sharp rise in the market is a buy signal, rather than a sell signal. This explains why investors find it so difficult to get out of the market at its peak.

 

Financial Definition of a Bubble

One of the problems with spotting economic bubbles is economists don’t agree on the actual definition of a bubble in the first place. One concept to defining a bubble is that it occurs when the price of an asset rises by more than two standard deviations above its previous long-term trend.

 

Another approach is to look at the fundamentals. Typically, asset prices are expected to reflect the current value of future cash flows. In theory, a doubling in the market could reflect a sudden improvement in the outlook for that asset class.

 

One reason there a several different opinions on what is the start of an economic bubble is that bubbles aren’t usually obvious until they’re underway, or more to the point, when they have already taken a turn.

 

What could seem like the “next big thing” may not reveal itself to be a catastrophic economic bubble until it bursts, as in the case of the tech bubble that occurred at the beginning of the new millennium.

 

The Tech Bubble

The tech bubble, or dot-com bubble, was a purely speculative bubble that occurred around 1995 – 2001 when the stock markets in industrialized countries saw their equity value rise rapidly, and extraordinarily, due to the growth in the internet sector and related fields.

 

Since the tech bubble was caused by the recent rise in the internet it seemed that it was a result of the current times and the ever increasing use and value of the World Wide Web itself. People figured that there was nowhere to go but up.

 

The Birth of the Day Trader

One factor that fueled the bubble to greater and greater heights was the introduction of easier, less expensive stock trading. This allowed anyone the ability to easily and affordably trade stocks. This lead to “day trading” by inexperienced investors. People were buying stocks and holding them for a day, or even a couple of hours and then selling them. When the great sell off came in 2001 it was catastrophic.

 

Timing the Market

None of this is very encouraging since there really isn’t one effective way to spot a bubble until it’s too late. However, it makes sense because if timing the market were possible, major price swings wouldn’t be an issue in the first place.

 

Thank you for taking the time to visit my blog. I sincerely hope that my blog entertains, helps and gets you thinking. Please take a minute to leave a comment to start and interesting conversation, or add your interesting thoughts to an existing conversation.

 

For more thought provoking articles please check out:

Forex Trading Strategies

How Does a Herd Instinct Affect Trading in the Forex Market?

Frequently Asked Questions About Forex Trading

Staying Motivated in your Job Search

Why Your Free Credit Report Is So Important

Online Stock Market Investing the Correct Way

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Investing in the stock market isn’t for the faint of heart, nor is it for the inexperienced. It takes education and practice to choose the right online investment. The arrival of the internet has opened the world of investing in the markets to a wider variety of people.

 

In the past investing in the stock market was limited to the wealthy and to the banks. The internet has leveled the playing field. However, just because it’s easier and much more affordable for the common man to invest in the stock market, this doesn’t mean it’s any easier to choose a profitable investment.

 

Choosing the right online investment still takes knowledge and experience. Without both of these it’s easy to loose money fast, and in some cases, to loose even more than you initially invested.

 

Although, along with it being easier to invest in the market, there are also several websites teach the correct way to invest. On the other hand, there are just as many, if not more, sites that will take your money with a claim of teaching the correct way to invest, only to leave you with nothing in return.

 

The best advice for beginning investors is, be careful, do your research and remember there is no such thing as easy profits.

Why Your Free Credit Report Is So Important

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It’s extremely important check your credit score from time to time. Your credit rating shouldn’t only be checked when you’re thinking of making a large purchase, like a vehicle or a house, it should be checked on a regular basis. This is why free credit score reports are invaluable.

 

Make sure there aren’t any errors

A free credit score report makes it possible to keep an eye out for errors to your credit reporting so you don’t have any surprises. No one is perfect, that is why there are so many stories about people who have had errors reported on their credit rating and they didn’t find out about them until the damage was already done.

 

If left unnoticed for too long an error in your credit rating can cause all sort of problems when you try to correct. If they can be corrected at all.

 

Identity theft

Another extremely important reason for receiving an annual credit score report is it allows you to watch for people stealing your identity. Identity thieves will open credit cards in your name and use them until they aren’t of use any longer. If not caught soon enough, this could mean you are now on the hook for thousands of dollars charged on cards that you didn’t open.

 

Receiving a free credit card report lets you catch situations like this and react quickly to have the matter cleared up so that you won’t be responsible for the bill.

 

Your credit is very important

Even signing a contract with a cell phone provider requires a credit check. Same with renting a home or apartment and, in some cases, applying for a job. Since having good credit is this important, don’t you think it’s something you should check on a regular basis?

 

Making a major purchase

Everyone is aware of how important good credit is when it comes time to make a major purchase like buying a car or a home. Keeping an eye on your credit score means that there won’t be any surprises when you decide to make a major purchase and you will also know just where you stand and what you’ll be able to afford.

 

There are several benefits to receiving a free credit report regularly, not just when you’re planning to make a major purchase. The importance of staying on top of your credit score can’t be stressed enough. Sign up for a credit report today, you won’t be sorry.

Staying Motivated in your Job Search

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There’s no two ways about it, losing your job is extremely hard to deal with. Whether you lost your job because of your performance, a serious mistake you made or even if it had nothing to do with you or anything within your control, it’s just as difficult to deal with.

 

Over the last few years, millions of people found themselves without a job,in most cases the reason they were without work had nothing to do with themselves, it was totally out of their control.

 

No matter why you lost your job the most important thing is how you handle the aftermath. How you pick up the pieces is all that matters in this case.

 

When it comes to successful job hunting, your attitude is everything.

A positive, motivational attitude is the most effective tool you have and the most important one you’ll need.

 

We have come up with some very helpful traits that, when practiced, will keep you above the pack, and help you land, not just a job, but an even better job then you had, making sure the situation actually works out to be a promotion rather then losing your job.

 

Remain Focused on the Future

It’s much easier to get bogged down in a woulda, coulda, shoulda rut then it is to stay focused on the future and your long term goal. Your future goal should be to snag a better job then the one you just lost.

 

Don’t let your Job Status Define You

Of course, losing your job is a very personal experience. However, don’t take it too personal. The job you have doesn’t define you, it never has and it never will.

 

It is very true that people who interpret losing their job as a sign of personal weakness or failure are less likely to “get back in the saddle”.

 

Take Care of Yourself

When you lose your job, one of the easiest things in the world to do is to plant yourself on the couch, with a bag of chips and a few beers and wallow in self pity.

 

This is not a positive, nor a healthy, attitude. Mental and emotional resilience requires physical resilience. Workout, stay fit, keep in shape all of these things matter and will help you find another job.

 

Surround Yourself with Positive People

Emotions are contagious. When the people around you are positive and motivational, their outlook will rub off on you, helping you to land a great job quickly.

 

Work Your Network

The more people who know what you want, the more who can help you get it. The vast majority of jobs are never advertised. So the adage “Your network is your net worth” is particularly relevant when it comes to finding those jobs that are filled via word of mouth. Reach out to people you know and enlist their support in making any introductions or connections that could help you.

 

Treat Your Job Search as a Job

If you feel the need, and can afford to do it, give yourself a break for a few days or week or two. But assuming you can’t afford a year sailing the world on the Queen Mary, don’t take too long before returning to your familiar routine. Create structure in your day. Sure you have more time on your hands than you had before, but you will be amazed at how little you can do in a day if you aren’t intentional about what you want to get done.

 

Extend Kindness

It’s pretty simple really: extending kindness toward others makes us feel good. It’s not just a nice thing to do something for others – whether helping a neighbor or volunteering in a local soup kitchen – it’s actually a helpful thing to do for ourselves.

 

Scientists have found that acts of kindness produce some of the same “feel good” chemicals in the brain as anti-depressants. In addition, when we give our time to help others, it helps us stop dwelling on our own problems, and makes us realize how much we have to be thankful for. It can also can be an effective way to build your network, and show potential employers you are not sitting idly by waiting for work to come your way. There’s no better mood booster than making a difference for someone else, even when you wish your own life were different than it is.

Frequently Asked Questions About Forex Trading

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Even though the forex market is the largest financial market in the world, it is still pretty confusing to retail traders. Up until the internet made currency trading popular a few years ago, FX was usually only traded by large financial institutions, multinational corporations and hedge funds.

 

However, more and more investors are becoming more familiar with this fascinating market. That’s why we put together the answers to some of the top questions about the forex market.

 

What makes the forex market different from other markets?

Unlike stocks, futures or options, currency trading isn’t done on a regulated exchange. It’s not controlled by a central governing body, there aren’t any clearing houses to guarantee the trades and there isn’t any arbitration panel to settle disputes.

 

Members trade with each other based on credit agreements. Basically, transactions in the largest, most liquid market in the world depends on nothing more than a verbal agreement. This is why it’s crucial to always deal with only reputable retail FX dealers.

 

Does forex trading have commission fees?

Investors who trade stocks, futures or options usually use a broker, who acts as an agent in the transaction. For the task of taking the order to an exchange and attempting to execute the trade, using the customer’s instructions, the broker charges a commission.

 

The FX market doesn’t have commissions because it’s a principals-only market. FX firms are dealers, not brokers, which is a critical distinction. They make their money through the bid-ask spread.

 

The bid-ask spread is the difference in price between the highest price that the buyer is willing to pay and the lowest price the seller is willing to sell it for. Everything above the purchase price is profit.

 

What is a pip?

A pip is the “percentage in point” and is the smallest increment of trade in FX. In the forex market, prices are quoted to the fourth decimal point. The change in that fourth decimal point is call 1 pip and is typically equal to 1/100th of 1%.

 

What are you really buying and selling In the currency market?

In the FX market you’re basically buying and selling nothing at all, because it is purely a speculative market. There isn’t any physical exchange of currencies ever. All trades exist only as computer entries and are netted out depending on the market price.

 

What is a currency carry trade?

The most popular trade in the currency market is a carry, which is practiced by both the largest hedge funds and the smallest retail speculators. The carry trade rests on the fact that every currency in the world has an interest rate attached to it. These short-term interest rates are set by the central banks of the Federal Reserve in the U.S., the Bank of Japan in Japan and the Bank of England in the U.K.

 

The idea behind the carry is pretty straightforward. The trader goes long the currency with a high interest rate and finances that purchase with a currency with a low interest rate.
Forex trading can be fascinating and profitable, however, you need to have a clear understanding of how it works and how to trade so that you can make as much of a profit as possible, rather than losing your principal. Our helpful and educational articles can help you do this.

How Does a Herd Instinct Affect Trading in the Forex Market?

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In forex speak, “herd instinct” is the tendency of traders to blindly follow a trend or pattern that has been established by a large group of traders. These traders are often firmly abiding by the well-known investment term “the trend is your friend.” This principle usually provides better returns in forex trading than in equities trading for a couple of reasons.

 

First, forex trading is mainly driven by technical analysis to a greater extent than stock trading, since fundamental analysis plays a much larger art in equity trading then it does in currencies.

 

Second, even though the forex market is the world’s most liquid financial market with an estimated daily turnover exceeding $4 trillion, only six currency pairs, USD/euro, USD/yen, USD/sterling, USD/Australian dollar, USD/Swiss franc and USD/Canadian dollar, account for two thirds of this trading volume. In comparison, there are thousands of blue-chip stocks on the major global equity exchanges.

 

These currencies are closely watched by a majority of traders all around the world, and the same technical levels are monitored around-the-clock by these traders for buy and sell signals. When a key technical is triggered, other traders jump in and reinforce the initial trend, this compounds the herd effect.

 

Using the Herd Instinct in Forex Trading

The main theory for using the herd instinct profitably in the forex market is very simple, base your trades on the majority view and established trends in global markets.

 

If you are able to effectively time the markets, being a contrarian may enable you to profit in the stock market, but it can be disastrous in the forex market. A currency can defy fundamentals for so long and drift so far that it can test the resolve of even the best traders.

 

Tips for Herd Instinct Trading

Here are some tips to help you with a herd instinct trading strategy:

 

  • Watch out for trends that have been going on for a long period of time, they may be in danger of a reversal. Currency trends can reverse quickly, jumping into a trend that has been long-lived could wind up leading to huge losses if it makes a reversal.

 

  • Plan your exit strategy in advance when plotting a trend. There is safety in running with the herd as long as you have a plan to get out before your trampled on.

 

  • Trading discipline is very important in the forex market. That is why stop losses are critical, the high degree of leverage in retail forex can lead to financial ruin if you don’t implement strict trading rules for yourself.

 

  • Adding to a losing position is never a good idea. This is why “averaging down” is not a viable trading strategy in forex. Never try to catch falling knives.

The herd instinct can help you trade established trends in the forex market profitably, but be careful and use common sense while in the herd. Use stop losses, avoid complacency and plan your exit strategy.

Forex Trading Strategies

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There are a variety of currency trading strategies available. However, most of the strategies fall into one of two broad categories: hedging and speculating.

 

Hedging

When companies sell goods or services in foreign countries, they are normally paid in the currency of the country in which the sale occurs. However, currencies continually fluctuate, causing the sale to be valued (in the home country) at less than hoped for or expected profits.

 

However, companies can hedge, to avoid possible losses from fluctuating currencies by trading currency pairs. Protection against the possibility of adverse currency movements helps companies focus on generating revenues without worrying about loss in value.

 

Speculating

Other investor activities will fall under the broad category of speculation, which involves buying or selling a financial asset. This is usually done with expected higher-than-ordinary risk, in order to take advantage of an expected move.

 

Speculators in the currency market wager that, in the future, the value of a currency will move higher or lower relative to another currency. Speculators in the currency market can include hedge funds, commercial banks, pension funds or investment banks, in addition to individual investors.

 

Currencies are traded in pairs, so in any given transaction, a trader is wagering that one currency will rise, while the value of the second will fall.

 

Additional trading strategies

 

Beside the trades that focus on the relative value between two currencies, there are several other popular types of currency trades. Arbitrage trades are trades where the investor simultaneously buys and sells the same currency at slightly different prices, in the hopes of making a small, risk-free profit.

 

Even though this is a very attractive and prefered trading strategy, arbitrage opportunities are very rare in efficient markets because there are many other investors who are also watching out for these opportunities. This means that any arbitrage possibilities that do exist disappear quickly.

 

Investors who are interested in arbitrage opportunities need to monitor market developments closely and when the opportunity appears, they need to act quickly. When the opportunities do appear, the price differential is usually very small. To generate a substantial profit, investors need to trade in large enough quantities to increase their profits.

 

Another popular currency trading strategy is the carry trade. This strategy involves selling the currency of a country with interest rates that are very low and investing the proceeds in the currency of a country with high interest rates. This strategy allows the trader to generate a profit as long as the relationship between the two currencies is relatively stable.
The carry trading strategy is usually performed by large, sophisticated investors, like hedge funds, and is extremely popular during times of low market volatility. During high volatility, large fluctuations in the value of currencies and other financial assets can quickly overwhelm the traditionally slow-and-steady profits found in the carry trade.