Hi, Friends
Welcome to the third issue.
If this newsletter was forwarded to you
The Greater fool theory
What goes through your mind when you buy an asset- say a house, car, gold or even art?
Do you buy an asset for its utility or you buy solely to sell at a higher price?
You act per the greater fool theory when you buy an asset without considering valuation fundamentals and other important factors because someone else (the greater fool) will buy it at a higher price.
The greater fool theory states that you can make money from securities, whether they are overvalued or not, by selling them to someone else will buy it at a higher price.
When you purchase an asset only to sell to someone else at a higher price, you participate in the greater fool theory.
“What the wise man does in the beginning, the fool does in the end.”
This isn’t necessarily bad; however, investors should be aware of what they are doing.
For example, the tulip mania, a period when prices tulip reached extraordinarily high levels, and then dramatically collapsed in February 1637.
The housing bubble and the dot com bubble are examples of famous bubbles that have crashed recently.
When there is euphoria about an asset, it is usually a bubble. A bubble is a situation when an asset at a price or price range that strongly exceeds the asset's intrinsic value. Like always, bubbles burst.
When an asset's price shoots up and deviates from its value, people get interested and want to join on the ride. This is where FOMO(fear of missing out) comes in.
Then we join the crowd and buy, which pushes the price higher because the demand is higher than the supply. At this moment, people who had already bought begin to sell and participate in the theory. The more people buy, and the cycle goes on until…
A bubble bursts when the demand falls. This could be due to different reasons, like people can’t afford it, or the object gets abundant.
How to Avoid Being a Greater Fool
Do not blindly follow the herd.
Do your research and follow a plan.
Adopt a long-term strategy for investments to avoid bubbles.
Control your greed and resist the temptation to try to make big money within a short time which is a subset of FOMO
Understand that there is no sure thing in the market; nothing lasts forever.
Let me leave you with a question.
Is crypto and by extension, bitcoin a bubble?
PS: Crypto is not Blockchain.
Pictures
Readings
Tulip mania: The flowers that cost more than houses
1636 Tulip Mania, GameStop, Crypto & Social Media
Tools and Resources
Websites apps I find useful:
That wraps up this week’s newsletter. Until next week, take care!
Muhammad Tahir.
If you want to discuss any of the ideas mentioned above or have any books/papers/links you think would be interesting to share in a future edition, please reach out to me by replying to this email or sending me a direct message on Twitter @iamuhammadtahir.
Just learned what a bubble is thanks to your great explanation. I'm not familiar with stock investing. But what you write is so enjoyable to read. I'm still exploring ways to invest my income and your newsletter offers so many great advice for investment. Thanks so much!