What is a bull market?
A bull market is a period during which prices are in an uptrend and investors are optimistic and confident.
Does a bull market guarantee profits?
Surely it is easy to make a profit when prices are consistently rising? Not necessarily. Investors at any level can lose money in a bull market. Beginners, experienced investors, and even the world’s top investors alike have been caught out during bull markets. A bull market does not guarantee profits.
Four phases of a bull market
Sir John Templeton once said “bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. In terms of gold, silver, and the miners, we have left the pessimism stage and are currently in the skepticism stage. Note that most of the gains in these sectors tend to occur in the euphoric phase. The path to the euphoric top is not a straightforward one and investors can fall foul to a variety of pitfalls along the way. Here we will discuss some real life stories to highlight some important lessons. These stories do not necessarily reflect poorly on those involved. All investors have had, or will have similar experiences at some point.
The newbie investor
A student in his mid-20s was on a meager student stipend and he also worked during weekends to supplement that stipend. He had dabbled in the stock market for the first time in 2016 and had made about a small single figure percentage profit. That gave him a little bit of confidence. Due to his young age, he had never experienced a bear market.
He became interested in cryptocurrencies in 2017 and decided to take a punt on XRP. In November 2017 he bought $10,000 worth of XRP at 20 cents each. It didn’t take long for price to rise. Indeed, the price rose sharply, almost vertically as shown on the chart above. He watched the price double, triple, quadruple, and by new year’s day he had a 10 bagger on his hands. As each day went by he was calculating how much money he had earned that day, and it was a lot more that that he was earning from his work and his student stipend. He was imagining higher and higher returns. The price finally peaked at $3.50 and at that point his investment was worth $175,000. That sum would have made a difference to his life, but he didn’t sell in the hope of even more gains. He expected this bull run to continue indefinitely. Having never experienced a bear market, he was not aware of the dangers of rapid price rises.
As January 2018 progressed, the price of XRP plummeted. Although this was a shock, he still had hope that the price would turn around and rise to exceed its previous peak. alas, that did not occur. There were a couple of bounces on the way down and he still held on. When a further drop in price occurred in August 2018, he capitulated he sold his holdings at 35 cents each. He found the whole experience emotionally exhausting and was very unhappy with the outcome. He had actually made $7,500 in profit (a 75% return) and it would have taken him a lot of weekends of work to earn that amount but his thoughts were fixated on how much he could have made. Gains that weren’t realized can feel equivalent to a loss.
Lessons from the newbie investor
Don’t expect a bull market to continue indefinitely. This is a common thought during the euphoria phase of a bull market. Everyone is positive and optimistic about the market during this stage and anyone who suggests that prices are going to fall will be berated.
Another lesson to learn from this story is to take profits on the way up. Although that sounds very sensible and straightforward, in reality it is tough to sell a rising asset. One potential strategy is to take out your original investment once the stock has doubled or tripled. The remaining stocks are effectively free, and that removes some of the emotion when managing that holding. Having an exit strategy is important. Think about the factors that would make you sell.
The genius investor
There is no doubt that Sir Isaac Newton was a genius. Additionally, he was wealthy and was an experienced and cautious investor. Most of his investments were in government bonds which gave him a good stream of income. He also owned a few stocks and one of those stocks was the South Sea company, which he was an early investor of at £100 a share.
At the end of 1719, Newton held £13,000 worth of South Sea company stock. At today’s value that is about £2 million. Four months later the stock had risen very nicely and he decided that he had made enough money. He sold all his stocks. making a profit of £20,000, more than doubling his initial investment. Indeed the profit alone was 200 years worth of salary as a Professor at the University of Cambridge. Although he was initially happy with this result, the stock price rose steeply as the euphoric stage of the mania progressed. Over this period, Newton’s friends were making handsome profits while he was sitting on the sidelines. He felt like he was missing out and was very unhappy that he had sold his stocks too soon.
Eventually it all became far too much for him and he decided to jump back in. Not only did he reinvest the profits he made, he invested a lot more. The stocks initially rose but then price topped out and came crashing down. Newton’s losses were catastrophic, amounting to an estimated $4 million at today’s value.
As well as the financial loss, Newton also took an emotional battering. At the time he was regarded as one of the smartest people alive. He therefore couldn’t comprehend this failure, particularly when those of lower intellect than he had managed to exit before the peak and made good profits.
Lessons from the genius investor
Don’t mistake a bull market for genius. Rising prices and rising profits can make investors overconfident. Mathematical and scientific intellect is not necessarily correlated with success in the markets.
Newton made the mistake of adding much bigger bets during the euphoric phase. As the bull market progresses, the risk reward asymmetry decreases Ideally, the majority of investments are made when the risk reward asymmetry is large (small downside, large upside potential). That means having most of the investments in place during the pessimism and skepticism phases of the bull market.
Emotions do play a big role in decision making and it was fear of missing out (FOMO) that led Newton to re-enter the stock in the late euphoria stage. Newton explained his lapse by saying “I can calculate the motions of the heavenly bodies, but not the madness of people”.
A top investor
Stanley Druckenmiller is one of the world’s top investors. In the 1990s he worked at George Soros’s quantum fund, and in early 1999 he decided to short $200 million worth of tech stocks. At the time the tech sector had been in an uptrend for years and he thought the tech sector was becoming overheated. It turned out he was early in his call, and as prices rose he was forced to cover those shorts a few months later, leading to a loss of $600 million.
Two young whippersnappers at the fund were making money as tech stocks continued to rise and their small account was up 50% on the year, while the quantum fund was only up 7%. That drove Stanley nuts and that is when FOMO set in. He had the urge to get back into tech stocks during the euphoria phase but there was a voice in the back of his head which said don’t do it, don’t do it. He listened to that voice for about a week, but prices kept rising. He finally ignored that voice and bought $6 billion worth of tech stocks. He had bought those stocks within hours of the top. Six weeks later he was sitting on a loss of $3 billion dollars.
Stanley said that he knew deep down that he shouldn’t have done it, but he was an emotional basket case at the time.
Lessons from the top trader
When a trend is in place, avoid betting against it. Stanley shorted a stock that was in a strong uptrend. Going short in a strong bull market is certainly not for the faint-hearted.
Just like Newton, Stanley added larger bets during the euphoric phase which meant greater risk (low risk reward asymmetry). It was FOMO that led him to make those large bets during the euphoric stage.
These three real life stories describe how bull markets and bubbles were handled by three different investors; the newbie investor, the genius investor, and the top trader. Despite the wide range of investing experience, all described themselves as being an emotional basket case during the euphoria stage of the bull market, and emotions misled their decisions.
No one is completely immune from these emotions, but hopefully if we are thinking about this well in advance, we can learn from these examples when gold, silver, and mining stocks enter bubble territory.
Most of the investments should be placed during the pessimism and skepticism stages of the bull market because the risk reward asymmetry is high. Those investments should be held until reaching the euphoric stage, and the euphoric stage should be used to sell holdings in a staged way. This allows profits to be taken while also making additional gains on the remaining holdings if prices continue to rise, because euphoria can go on much longer than expected. The euphoric stage is not the time to be adding bigger bets than those placed early phases of the bull market.