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The Stages of a Market Mania
What is a mania? It is defined as a mental illness characterized by great excitement, euphoria, delusions and overactivity. In investing, this translates into investment decisions being driven by fear and greed without being tempered with analysis, rationale or balance between risk and reward outcomes. The craze usually runs parallel to the business development of the product, but the timing can sometimes run awry.
The late 90s technology.com boom and today’s cryptocurrency boom are two examples of how a craze works in real time. These two events will be highlighted with each phase in this article.
The idea stage
The first phase of a craze starts with a good idea. The idea is not known to many yet, but the potential for profit is enormous. This is usually translated as unlimited profit, as “something like this has never been done before”. The Internet was one such case. People who used the paper systems of the time were skeptical, as “how can the Internet replace such a familiar and entrenched system?” The backbone of the idea is starting to be built. This translated into the modems, servers, software and websites needed to turn the idea into something tangible. Investments in the idea stage start slow and are made by people “in the know”. In the case, it can be the visionaries and people working on the project.
In the cryptocurrency world, the same question is asked: How can a piece of crypto code replace our monetary system, contract system and payment systems?
The first websites were crude, limited, slow and annoying. The skeptics would look at the words “information superhighway” thrown out by the visionaries and say “how can it really be that useful?” The forgotten element here is that ideas start at their worst, then evolve into something better and better. This sometimes happens because of better technology, more scale and cheaper costs, better uses for the product in question, or more knowledge of the product combined with good marketing. On the investment side, the early adopters are coming in, but there is no euphoria and astronomical returns yet. In some cases, investments have yielded decent returns, but not enough to make the masses jump in. This is analogous to the slow internet connections in the 1990s, internet pages crashing or information being incorrect on search engines. In the cryptocurrency world, it is witnessing high mining costs for coins, slow transaction times and hacking or theft of accounts.
It’s starting to get out that this internet and “.com” is the hot new thing. The products and tangibility are being engineered, but due to the massive scale involved, the cost and time spent would be enormous before everyone uses it. The investment aspect of the equation starts to come ahead of business development as markets discount the potential of a business with the price of the investment. The euphoria is starting to materialize, but only among the early adopters. It’s happening in the cryptocurrency world with the explosion of new “altcoins” and the big media press the space is getting.
This phase is dominated by the parabolic returns and potential that the Internet offers. Not much thought is given to the implementation or the problems because “the returns are huge and I don’t want to miss anything”. The words “irrational exuberance” and “mania” are starting to become common as people buy out of sheer greed. Downside risks and negativity and largely ignored. Symptoms of the mania include: Any company with a.com in its name is red hot, analytics are being thrown out the window in favor of optics, investment knowledge is becoming less and less apparent among new entrants, expectations of 10 or 100 bagger returns are common and few people actually know how the product works or doesn’t work. This has played out in the cryptocurrency world with the amazing returns of late 2017 and incidents of company stocks jumping hundreds of percentage points by using “blockchain” in their name. There are also “reverse takeover offers” where shell companies that are listed but dormant have their names changed to something involving blockchain and the shares are suddenly actively traded.
Crash and Burn
The business scene for the new product is changing, but not nearly as fast as the investment scene is changing. Eventually a shift in mindset emerges and a huge sales frenzy begins. The volatility is massive, and many “weak hands” and wiped out from the market. Suddenly analytics are being used again to justify that these companies have no value or are “overvalued”. Fear spreads and prices accelerate downwards. Companies that don’t have earnings and survive on hype and future prospects are blown out. Incidents of fraud and scams rising to take advantage of greed are exposed, causing more fear and selling of securities. The companies that have the money quietly invest in the new product, but the rate of progress slows because the new product is “an ugly word” unless profits are convincingly demonstrated. This is starting to happen in the cryptocurrency world with the folding of lending schemes using cryptocurrencies and more cases of coin theft. Some of the marginal coins decline in value due to their speculative nature.
At this stage, the investment landscape is charred with stories of losses and bad experiences. Meanwhile, the good idea is becoming tangible, and for companies that use it, it’s a boom. It begins to be implemented in daily activities. The product is starting to become the standard, and the visionaries are quoted as saying that the “information superhighway” is real. The average user notices an improvement in the product and it starts mass adoption. The companies that had a real profit strategy take a hit during the crash and burn phase, but if they have the money to survive, they make it to the next wave. This has not happened in the cryptocurrency world yet. The expected survivors are those with a tangible business case and corporate backing – but it remains to be seen which companies and coins these will be.
The Next Wave – Business catches up with the hype
In this phase, the new product is the standard and the profit becomes apparent. The business case is now based on earnings and scale rather than the idea. Another wave of investment is emerging, starting with these survivors and extending to another early mania. The next phase was characterized by social media companies, search engines and online shopping, all of which are derived from the original product – the Internet.
Fads work in a pattern that plays out in the same way over time. When you recognize the stages and thought process of each one, it becomes easier to understand what is going on and investment decisions become clearer.
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