This is an excerpt from the Liberated Stock Trader Book and Training Course.
Why do Booms and Busts occur?
Take for example the famous DOTCOM boom of 2000. Greed surged into the marketplace on the misplaced belief that new Internet-based technology would fundamentally shift the market dynamics and business models of the future. Technology became fashionable and “Bricks and Mortar” businesses were perceived to be outdated and almost worthless. This paradigm shift meant that money poured into technology stocks at an unrepentant rate and money poured out of “Bricks and Mortar” stocks at an equal rate.
A telltale sign of problems to come was really noticeable when stock analysts would suggest Price Earnings valuations on tech stocks of 200, 300, or more were reasonable even though the companies in question had never made a profit.
What is the Price Earnings Ratio?
The Price Earnings Ratio is the ratio of the Stock Price to its actual earnings. If a P/E Ratio is at 30 then it would take the company 30 years to earn back the share price. The higher the P/E ratio the higher the expectation that the stock will perform well in the future. You can also see the P/E ratio as a valuation of the worth of the stock if the P/E is 200 you are essentially paying 200 times the earnings capacity of the company.
In the Year 2000, the P/E Ratio of the S&P500 reached nearly 45.
This was an all-time high and essentially indicated that the expectation of the market participants was completely unrealistic. By the time the inevitable correction was completed the P/E Ratio for the S&P500 had halved to just over 20. Much of the greed and hype was fueled by professional analysts and so-called market gurus. They became greedy and euphoric, a heady mixture. When everyone slowly began to realize that the huge profit expectations would not be met by the tech industry, the entire sector collapsed bringing with it other industries, indexes & markets. The Tech Bubble had burst.
How does this affect our investments?
The boom is good for our investments in the short term but only if we move into cash before the bust, which of course only the enlightened few ever manage to achieve.
So who suffers the wrath of the Bust? The private investor, you and I! We lost money in our pensions, our mutual funds, and our stock portfolios; we lost jobs, earning power and our appetite for risk.
It seems that the time interval between the economic crisis and the boom-bust sequence is happening at shortening time intervals, so it always pays to beware. When every analyst is screaming “Buy Buy Buy” and acting like the best thing in the world is happening, that is the time to be most careful.
When all the market reports are reiterating what a depressing time it is, how there is no future in the stock market and when prices have lost 20% or even 50% of their value, that could possibly be one of the best times to buy.
Other Chapters of the Liberated Stock Trader Book are listed below
This chapter sets the stage for the two key areas of stock market technical analysis and the fundamental analysis of companies including macro and microeconomics
This chapter looks at what REALLY makes the markets move, what causes boom and bust cycles, and how to spot them.
What are stock market cycles and the cycles of business and economies? Important information that you need to appreciate as part of your core analysis.
Next we move into fundamental analysis and the financial fitness of a company. All the major indicators and measures are covered.
Stock screening means using criteria to shortlist the kind of stock that you want to purchase. A vital part of any stock market training
Once you know the business climate, the state of the economy and you have shortlisted the stocks you want to buy. The next thing to do is the technical analysis. Even if the company looks great on paper, if the stock price is plummeting you do not want to buy it until it has bottomed out. This is called catching a falling knife. This is what chart patterns and technical analysis help with.
Here we get into the art of drawing on charts to help you visualize the Supply and Demand on the stock, the direction of the trend, and estimate how long the trend will last. Vital for you to establish buy and sell signals.
Which indicators should you use, there are literally hundreds of stock chart indicators? Each has a specific use case and application, which should you use?
Volume is a vital indicator along with the price. Both of these you need to understand in granular detail, you will learn everything you need to know.
Moving to advanced technical analysis we cover indicators such as parabolic SAR and point & figure charts.
How are the market participants feeling? Positive, Negative, or indifferent. Consider that 90% of people fail to beat the average market returns, sentiment indicators can be a great contrary indicator. Learn how to use them to your advantage.
Understanding how you want to invest, how much time you have, and your time horizon. These questions all help you to understand what type of investor you want to be, this then enables you to select the right strategy for you. Then we move on to building your stock investing system, a critical element to your plan.