How Investor Sentiment Changes and Why It Matters

Stock Market and Cryptocurrency Bubbles

1. Irrational stock market behavior

While the stock market is usually driven by rational investing common sense, exceptions do occur from time to time. This is when the overall market or a specific industry creates irrational stock prices at certain times. However, this phenomenon is not a problem in itself, as stock prices are heavily influenced by emotions as well as rational judgment.

2. Clusters and bubbles: centered around cryptocurrency mania

However, what we should be concerned about is when this emotional sentiment turns into herd mentality and creates extreme skewness. This is when bubbles are most likely to occur.

The cryptocurrency mania of the winter of 2017 is a great example of this: many people took irrational actions in the name of a "new paradigm." The result was a severe bubble, and many people lost a lot of money.

3. Evidence of herd mentality: Analyzing analysts and reactions to articles

We often observe extreme reactions to analysts issuing bubble warnings or neutral articles, as well as opinions predicting that already overvalued stocks or sectors will still rise.

If you see any of the above evidence in any sector/stock market at the moment, you should take it as conclusive evidence that there is a severe skewing of the crowd in that sector/stock market.

4. The importance of staying cool: What to do when a bubble bursts

The process of bubble formation is often filled with excitement, but the key is to remain calm and collected.

This is because when the bubble bursts, everyone is in competition with each other. At that point, you can lose a lot of money if you don't keep your cool.

Therefore, if you believe that a particular industry is entering a bubble phase, instead of reacting to it, you need to keep a cool head and revisit your investment strategy. This will help you minimize your losses when the bubble bursts.