Bubbles occur at the end of long bull markets. When markets go up long enough the wall of worry starts to dissipate. Traders assume the markets are bulletproof, where every correction is a buying opportunity. Corrections become more shallow as more and more people buy into the market. The wall of worry crumbles and the markets go vertical and parabolic.

As the market goes parabolic, many unsophisticated investors enter the market. They have no idea what is going on they just want to get rich like everyone else. They are afraid of getting left behind, even though they are entering the market in the later stages of the bull market. They are willing to pay any price and that fuels the parabolic move in the market.

When these investors don’t have a wall of worry they will invest. The wall of worry had kept them out of the market and now they are late getting in. Finally, you run out of buyers and the markets correct which seems normal. Pullbacks no longer scare people but present buying opportunities.

Having stretched well above the 200-day moving average a correction begins to take us back to the mean. The recently invested unsophisticated investor starts to see his profits vanish and even some capital as the move to the mean occurs. They will continue to hold and usually the markets will bounce, convincing them that it is just a correction, no need to worry. But, this is just a dead cat bounce and the markets accelerate to the downside.

Now they are totally underwater and their visions of getting rich have evaporated. They are now watching their life savings evaporate. They have lost too much money at this point so they can’t sell. They ride it all the way down and then they sell.  How much they lost is determined by the size of the bubble.

Bitcoin is the 2nd largest bubble in the history of the world, challenging the Dutch tulip bubble market in the 1600’s. Bitcoin could lose 80-90% of its value when it implodes.

This is how bubbles behave and what drives bubbles. It is the reason that most unsophisticated investors never make money off a bubble. It is a time of greed and when everyone has departed the markets it may take years of true fundamentals to improve enough to drive a new bull market

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