An Absolute Beginner’s Guide to Trading Bubbles
| Lesson 0: Why Doesn’t Everyone Do This?
One of the most profound effects of social media appears to be that it creates bubbles everywhere. Throngs of people follow a trend and go on a march, cancel a celebrity, or buy a stock.
There has never been a better time to learn about how to trade bubbles, especially for the small trader who is looking to earn enough money to pay off their student loans, a mortgage, or simply build enough money to retire shortly–in say, 9 rather than 45 years.
We all have different risk tolerances and are at different stages of life. I am more aggressively minded than those looking to retirement, but I also already have enough money that I manage an entire portfolio.
My goal with bubbles is to use them to boost about 20% of my portfolio with 300%-700% annual returns. I also accept that each individual trade could have a 35%-39% down-side. I’m comfortable with that. If you decide to trade bubbles, you need to be comfortable with that too.
Very simple mathematics can tell you what to expect with those sorts of returns. Use this compound interest calculator (it’s the most intuitive one out there) and you can get a sense of what is at stake. If you start with $2500, add $500 each year, and retain 150% in returns (after taxes) each year, you’ll have more than $10,000,000 in 9 years.
Notice, the point is not to get one trade that will make you a millionaire, as r/wallstreetbets aims at. You must gamble for that kind of return and most people will lose everything. The art of trading bubbles is to learn to identify good bubbles and trade them with a real sense of
- when you will take your earnings and not earlier, and
- when you will exit your trade with a loss if things go wrong.
That’s the whole point of this site and newsletter. I’m providing the main lessons for free because I want to help ordinary folks get out of the rat race.
My paid subscribers get weekly or daily (depending on their subscription level) updates on the trades that I’m making and the results of the proprietary algorithms that I use to figure out mostly when I absolutely have to sell.
I have skin in the game with you, if you are a paying subscriber, since I tell you exactly what I’m trading.
In my experience, not knowing when to sell is the reason why most people lose money. That’s why, starting at $15 per month, I decided to give you all access to trades and data.
Still, I get a lot of questions from readers that want more development on the basics. They want to know:
- Where can I buy both stocks and cryptocurrencies?
- What exactly is the difference between a broker and an exchange?
- What’s the exact difference between a value investor and a momentum investor?
- Can you combine those strategies? (Yes, that’s exactly what I do).
As a result, I’ve come to realize that in addition to my Lessons in Bubble Trading and Deep Dives aimed at sectors, I need a series devoted to the concerns of beginners.
I have put together a terminology guide called “The Most Interesting Resource of Financial Terms You’ll Ever Read.” My goal there was to do a better job at explaining how to use various financial ideas, rather than merely define them as Investopedia does.
But you’ll need more than those terms to get started. To make sure you are on solid footing, I’m putting together a multi-part lesson plan that will bring you up to speed so that you can trade bubbles intelligently.
Here are the Contents
Lesson #1: The Mechanics of Exchanges and Trades (Save Literally $25 Each Trade)
- Where Can I Go To Buy Stocks?
- Where Can I Buy Bitcoin and Other Cryptocurrencies?
- What’s The Bid-Ask Spread About?
- What are Limit Orders and Why Should I use Them?
Lesson #2: Learn The Structure of the Stock Market (100% Returns For Free?!)
- What Exactly Is “The” Stock Market?
- What Happens When I Place A Buy Order?
- The Exchange Trade Up – Stocks
- The Exchange Trade Up – Cryptocurrencies
Lesson #3: The Structure of Stock and Crypto Indices
- What Is An Index Good For?
- The Standard and Poor 500 Index
- How Flaws In The Index Create Opportunities
Lesson #4: Identifying The Value of Stocks
- Relative v. Intrinsic Value
- The Easy Way to Identify Relative Value
- A Better Way to Identify Relative Value
Lesson #5: Identifying The Value of Cryptocurrencies
- Is Bitcoin An Asset?
- Why The Stock-to-Flow Model Is Wrong
- Why Metcalfe’s First Law Works In Theory
- Why Metcalfe’s First Law Is Hard In Practice
Lesson #6: Trading With Tea Leaves (How Not To Trade on Emotion)
- The Origin of Technical Investing
- Patterns in Price Movements
- The Problem With Untestable Strategies
Lesson #7: Trading With Momentum
- The Idea Behind Momentum Trading
- Evidence For Its Effectiveness
- Some Bad Ways To Use Momentum
- Combining Momentum With Value Investing Through Economic Signals
Lesson #8: Am I Too Late For This Bubble? A 3-Step Solution
- Good Risk / Reward Ratios
- But What About When I’m Late To A Bubble?
- Case Study: Bitcoin
Lesson #9: The Simplest Way To Make Money During A Crash (2.4x Better Than HODL-ing)
- What Is Dollar Cost Averaging?
- What Is Crash Cost Averaging?
To begin this series, though, I want to answer one basic question everyone should have at this point.
Consider this Lesson 0.
Why Doesn’t Everyone Do This?
Given the growing popularity of r/wallstreetbets, I think the facts of the matter now are: many millions of people are trying to do this. They’re just trying to get rich from one trade rather than a series of smart trades over several years.
Yet, given that the large investment firms on WallStreet have literal trillions of dollars at their disposal, you might reasonably wonder why they haven’t tried to trade bubbles more aggressively.
I think there are three main reasons.
1 Risk Tolerance
I’ve already mentioned this in the opening portion of this post, but it bears repeating: this is not a strategy that works well if you are just about to retire.
Now, I do use the Basic Economic Cycle indicator (from my algorithms) to identify when I should shift the mix of stocks, bonds, gold, and cash in my retirement accounts. So part of what goes into bubble trading is helpful for that stage of your life.
Still, if you are looking at retirement, you need to be able to count on stable month-to-month flows. Bubble trading is not that. You can expect that your bubble portfolio will have drops of 30% every two months or so. Unless that drop comes from the end of a bubble, then it’ll go back up and gain more. But it’s still hard psychologically.
That’s why, even for a person like me who is nowhere near retirement, I am not willing to put my entire portfolio into a strategy like this. That’s why I take a sort of second-best approach with my investments and only have about 20% invested in bubble trades.
But this isn’t the only reason why everyone isn’t doing this.
2 Small Funds
A second reason, and the main reason why WallStreet isn’t trying to trade bubbles in the way that I do, is that you just can’t do it with billions of dollars.
If you tried to buy $10,000,000,000 of Bitcoin, you’d move the whole cryptocurrency market. I mean that you would be buying so much Bitcoin that you would move the price up on your own, making your own bubble just through your own buys.
Ray Dalio’s hedge fund alone, Bridgewater, is worth $160 billion. So if he tried to invest just 16% into a strategy like this, he would end up owning most of the world’s Bitcoin.
Alternatively, a lot of the best companies that I trade for bubbles are “small-cap” stocks, meaning that they might only be worth $50 million total. Dalio could buy the entire company and it wouldn’t even be .1% of his portfolio. It just wouldn’t be worth it.
So, I hope you understand the point I’m trying to make. Most people on WallStreet have so much money that they can’t possibly use this strategy. The assets that we’re after are too small.
But that also makes this a perfect market for “small” investors, but which I mean anyone with less than $10,000,000 to trade.
3 Can’t Monetize Other People’s Money
A final reason is that WallStreet is in the business of managing other people’s money. Yes, they put up some of their own, but their main job is to manage the money of clients.
Now cycle back to point one about risk tolerance. How easy is it to convince someone else that losing 30% of their money, every couple of months, is just normal?
If you’re wealthy (and if this strategy could scale to large sums of money), who would you choose?
- Option one, the guy who says: yea, I’ll lose $3,000,000 of your $10,000,000 every couple of months, but it goes up after 5 out of 7 times and has a high probability of out-performing everything else.
- Option 2, the guy who says: I will make you a stable 14% return on your $10,000,000 with no significant draw-downs.
Remember, 14% of $10 million is $1.4 million. Could you live on that annually? Do you even need the services option one is offering?
The point, then, is that strategies like bubble trading do make a lot of money, but the way that they do it also makes it hard to gain and keep clients.
Since WallStreet actually makes money by keeping clients and only indirectly by making money, they have no reason to try using a strategy like this one.
So there you have it, Lesson 0 in the Absolute Beginner’s Guide to Bubble trading. Now you know:
- What kinds of gains you can reasonably expect from trading bubbles.
- What kinds of losses you might experience trading bubbles.
- Why I use bubbles as only one part of my portfolio, but your situation might be different.
- Why I use a basic economic cycle algorithm (to learn when I absolutely must sell).
- Why everyone isn’t trading bubbles.
I’ll be developing the other lessons over the weeks to come.
I’ll also continue to do deep dives and expand my general lessons in The Art of The Bubble too, but this is a start.
The Most Interesting Resource of Financial Terms You’ll Ever Read
General financial disclaimer: This post is provided for entertainment purposes only. I am not giving you financial advice and I am not a financial advisor. You should expect no financial returns one way or another based on my statements. These points hold equally for any statements that could be attributed to The Art of The Bubble or any related business entities. If you decide to buy or invest in anything, then your returns and potential losses are your own. No statements about taxation are taxable advice and you are encouraged to consult your own tax professional. You are also encouraged to do your own due diligence before investing in anything.