I have been increasingly thinking about whether if we are in a bubble state as the stock market has surged sharply over the past month. This made me to do some research on ways to recognize bubble and the following is what I have found on the net .

How Bubbles Grow: 12 Easy Steps

1. A believable concept offers a revolutionary and unlimited path to growth.

2. Surplus of funds and lack of opportunities lead to buying or investing in anything available.

3. An idea is complex and cannot be totally explained or related to an investor.

4. The crowd imitates the leader. All Aboard! Even the gardener has a tip!?

5. Prices fluctuate from traditional level to overvalued level, THEN to all new ground and all time highs.

6. New levels are sanctioned by experts. "We are in a new Paradigm!"

7. Fear of missing the boat takes over. Cloning of the idea occurs as many new overvalued competitors enter the market.

8. Lending practices are eased. Money flows like water to anything or anyone with a new idea.

9. Cult figures emerge for the new paradigm. The media promotes lifestyles, not substance.

10. The Bubble lasts longer than expected. Critics are dismissed. The last suckers are sucked in.

11. Fraud emerges as partly responsible for the bubble as the first cracks show in the bubble.

12. Finally, everyone has a reason why it cannot continue. But nobody dumps, and all hold onto their profits. No new buyers. Market stalls.

How a Bubble Bursts

1. A continued new supply of lower priced offerings occurs from rising prices. New IPO's get bigger and bigger

2. There is a rise in interest costs. The Government declares "Excessive Exuberance" and tightens credit too quickly.

3. Prices collapse and everyone heads for the exits at the same time. With no more buyers, prices hit free fall.

4. Fraud is uncovered in many diverse industries, and in monitoring and auditing agencies. This leads to more selling.

5. Governments intervene and give investors time to get out before the real decline.

Rules to Live By
1. Do not extrapolate the future from the present.

2. Trends continue for a long time (2-5 years) and then suddenly reverse chaotically. Witness the Tech Bubble.

3. Intermittent secondary corrections occur at Fibonacci Levels of 38%, 50% and 62% that result in classic Bull or Bear Traps.

4. Bottom picking begins several different times, trying to restart the Bubble, but to no avail. Massive losses occur to professionals trying to manipulate the markets.

5. Finally everyone recognizes that "Trends go further than you expect, and last longer than expected." Everyone gives up and sells.

6. As the volume of the decline decreases, a slow recovery begins.

Above points taken from http://www.solerinvestments.com/Online-Trading/Stock-Market-Crash.htm 


Despite personally worrying over the possibility of a bubble, I am still approximately 80% vested in the market now. Reason being, I believe there's more upside due to  1) lesser uncertainty over bank 2) more economic indicators showing it is recovering 3) Read some article mentioning a lot of cash are sidelined by fund houses meaning more fund will be flowing soon 4) Stock market is usually 3-4 months ahead of the economy.

I have came across an interesting an article on the net and decided to share it here. 

The techniques and the characteristics of the most successful investors are diverse, and there's not a guaranteed formula of success. Nonetheless, by following a similar path taken by successful investors, it can help to improve investment returns. Below are some of the key similarities between these successful investing strategies.

Measure your Results and Document your Decisions

I have came across an interesting article in seeking alpha and decided to post it here to share with everyone and also for future reference.

1) Say you bought a stock and it rapidly rallies but yet not to the point where you think it is at fair value. What to do? Sell half of the position, and wait. If the price falls, buy back the position. If it rallies further, sell the rest.

2) Say you want to buy a stock, but it is plunging. You have done your homework - the balance sheet is strong enough to self finance the company and it is currently valued at a huge discount, what to do? Buy half of a full position, and wait. If the company rallies sharply, sell the position. If it continues to fall, wait until it stabilizes, confirm the fundamental and buy up a full position.

3) Say you like a stock, but it has rallied past the buy point. What to do? Buy half. If the stock comes back to the buy point, buy a full position,. If  it rallies further, sell the position.

The real benefit of doing half is the psychology of the situation. Many investors suffer from fear, greed and regret. When the stock price moves in favor of profits, be glad of those profits. When the stock price moves against profits, reanalyze and either a) go flat, recgonize your mistake, and being grateful that it was small, or  b) increase the bet to full position, and be grateful that you didn't put a full position.

Scaling in and scaling out gives freedom to investors, and removing many of the psychological burdens that they bear. It dosent mean there won't be losses. There will always be losses but they will be easier to bear, with no panic that leads to selling off at the lows, or buying at the highs.

In short, money management is essential to successful investing or trading and this is precisely why I am currently putting more focus in this area.

Read the full article at  http://seekingalpha.com/article/131980-the-wisdom-of-half-positions .





Reproduced with permission from http://melynn-lynch.blogspot.com

I have been researching on the behavioral finance subject quite intensively recently as I believe this is one important area which I used to overlooked. Behavioral finance studies the potential decision making errors that  individuals can introduce into the investment process so by understanding the biases, it can help me learn about common decision-making mistakes.

Following are the list of biases I consolidated from an online article I came across..
Details can be found here .


- Optimism :  Unbalanced focus on “best-case” scenarios
- Regret Aversion :  Failure to make decisions out of fear of future regret.
- Overconfidence :  Excessive confidence in one’s ability to predict and make decisions.
- Cognitive Dissonance :  Using rationalizations to avoid change acceptance.
- Self-Attribution :  Attributing success to skill and failure to chance.
- Confirmation :  Focusing attention on information that confirms one’s beliefs.
- Hindsight : Exaggerated memory of one’s conviction about historical choices.
- Loss Aversion : Avoiding choices that may result in loss.
- Endowment : Favoritism based upon feelings of ownership.
- Illusion of Control :  False belief in one’s ability to control outcomes.
- Status Quo :  Resistance to change.
- Anchoring : Adjustment  Attachment to previous forecasts.
- Representativeness :  Allowing past experience to influence the interpretation of new information.
- Availability :  Favoring easily accessed information over full information.
- Conservatism :  Failure to fully recognize the value of new information.
- Recency :  Interpreting recent observations out of historical context.
- Ambiguity Aversion : Avoiding risk during periods of uncertainty.
- Mental Accounting : Innapproriately grouping assets before evaluating their characteristics.
- Framing : Varying a decision process based on a chosen context.

I am victim to most of the biases mentioned above.. i.e anchoring, I tend to derive an estimated value close to the present value as support in face of uncertainty If so, does that mean estimated values are only as useful as random number? Worse, occasionally I tend to use these value to reinforce my decision to buy stocks.

In my current system, I am using an estimated value to derive the entry and positioning so a question I'm asking myself is that, are absolute valuations derived from models like dcf applicable to the market? Is it better to use relative valuation instead or even so, don't use any?

Is there anyway to invest based on the difference between thinking and reality? Well, all the answers to the questions are still uncertain to me and I hope I can be enlightened soon by reading more or by any readers who are reading my posts.