If you’re a beginning stock trader venturing into the market for the first time, you should prioritize risk management and beware of bubbles. Even though there are many ways to make profits off trading, market volatility can scare traders into selling at losses. Here’s a way to approach market bubbles and how to avoid losses.
Inside Stock Bubbles: How They Inflate
Stock bubbles happen all the time, not just in certain periods like the dotcom bubble of the nineties. That particular era was a celebration of the early commercialization of the internet, although it was much like the California Gold Rush of 1849 that led to a lot more shovel buyers than miners getting rich off gold. The “dotcom bust” of 2000 reflected an awakening that many new websites of the era were worthless and full of hype that didn’t trigger profits.
Bubbles often form around companies that get mentioned in financial and broader media, sparking speculative optimism. Sometimes a surprising earnings report or news story can send a stock soaring higher than what the fundamentals suggest. Government decisions and politics can also play a role in which sectors rally after a new law passes or when new leaders are elected.
The cycles of bubbles followed by crashes go far back in history with the Crash of 1929 being the most classic example. The “Roaring 20s” was a time of great optimism with the unveiling of many new inventions that began to define the modern industrial world. During the decade stock prices got so high they became detached from reality. Sometimes all it takes is a few prominent financial experts to point out bubbles to trigger an avalanche of falling stocks.
Another way stocks get overvalued is from a “short squeeze,” which often involves big hedge funds. When short interest becomes heavy in a stock, meaning an army of traders are betting against it, a little bit of positive news can scare them into covering their positions. When a mob of traders start covering (buying after selling borrowed shares), it can unleash a “short-covering rally,” that drives the stock price vibrantly upward.
Using the Right Trading Tools
A big part of trading success comes down to financial research. But the market is so vast it’s impossible for one individual to learn which stocks are viable at any given time. Certain tools that connect you directly with the market, such as BullMarketz.com, can help you save time and money in searching for trading opportunities. It’s a firm that employs expert reviewers of financial products to help traders refine their choices for trading platforms and trading ideas.
Turning to experienced traders as mentors is an excellent way to develop your trading skills. Getting software that does the same thing but with more digital options at your fingertips makes trading even more powerful. Trading software gives you real-time market quotes and lets you see all kind of market activity that less equipped traders can see.
How to Avoid Crashing Bubbles
The number one way to guard against severe market losses as a trader is to develop a reliable risk management plan. No two traders have the exact same strategies, but what’s universal is the concept of protecting precious capital.
On any given trade you should calculate both the potential gains and losses. Then ask yourself how much money are you willing to lose on any given trade? Answering this question limits alarm bells when trades go the wrong way.
Some stocks can fly past their analyst targets and keep surging for weeks, such as Tesla in the 2020-2021 period. The stock rose to an unbelievable level of trading over 1,500 times earnings, which is considered to be more speculative than a standard bubble. Even stocks trading 100 times earnings are considered “overbought.”
Your risk management plan determines when you automatically exit a trade, such as when the stock falls a certain number of percentage points. Staying consistent with the rules you decide work for you is the most basic way to approach risk management. Using “stop loss orders” help cement your strategy, as you can set specific prices to exit the stock with automated tools or manually to avoid losses.
Conclusion
The easiest way to protect your trading capital is to use a risk management system you’ve developed through experience. Getting your hands on the right high-speed software that comprehensively tracks the market is another advantageous move. Ultimately, a trader must learn the difference between a bubble and stocks that reflect authentic growth.