The psychology behind bitcoin: How to spot a bubble

Raj Persaud
You find yourself starting to panic: have you missed the chance of a lifetime? (Source: Getty)

At the time of writing, the price of bitcoin is almost $17,000. In April, it was $1,000, which means that if you had bought then, you would have made more than seventeen times your investment.

Not bad. But, if you’d got in a little earlier, say in January 2016, you would have made over forty times your original investment!

Is there still time to get in, or is it a bubble about to burst?

Read more: People are mortgaging their homes to buy bitcoin

In the last few weeks, there have been forecasts of bitcoin hitting $1,000,000. But there have also been plenty of people warning of its imminent collapse.

What do you do?

Bubbles can seriously damage your wealth. But on the other hand, missing out is painful.

How can we know whether we are facing a bubble or whether it’s a sound investment? Do you stay out, or do you need to stop procrastinating and get on board before it’s too late?

The economist Peter Lawlor has said that “an asset bubble is like a psychiatric condition; it’s a pathology with well defined symptoms.”

Let’s see if I can help you to make your own diagnosis on bitcoin by looking for the symptoms.

Symptom number one

People who don’t usually get involved with active investment start to ask you what you think about the asset in question.

A good barometer for this is the conversation of taxi drivers. Taxi drivers, in our experience, usually like to start the conversation with politics or football. So when their opening gambit is investment, you know something is up.

The same principle was behind Joe Kennedy – father of President John F Kennedy – getting out of the market just before the crash of 1929. He decided the game was up when the young man shining his shoes gave him a stock pick.

Investment can be very dangerous, but as a bubble grows, people who aren’t really aware of the dangers get sucked in. When they do become aware, their panic will be excessive. And that’s one of the reasons why bubbles burst.

Symptom number two

People who do usually get involved with investment start to talk in terms of “if only”. “If only we’d put ten grand in back in March, we could have made millions by now.”

This “if only” talk, especially by professionals, is a step in the direction of suspended reason. Caution is temporarily thrown to the wind. Even professionals are tempted to venture into areas they don’t really understand. Greed temporarily dominates judgement.

They know they shouldn’t do this, and eventually their sense will return. Which is another reason why a bubble bursts.

Symptom number three

You hear more and more superhuman success stories. Wherever you go – dinner parties, restaurants, bars, even on the top deck of the bus – everyone seems to have a story about a friend (or maybe a friend of a friend) who has made an absolute fortune.

“I know a guy who put in a hundred quid back at the beginning – he’s just walked away with three million!”

These stories exert an almost irresistible pull, especially on your funds.

Symptom number four

You hear the dreaded words: “this time it’s different”.

During every asset bubble, you will find scores of professionals telling you that it isn’t a bubble; this time, it’s a real and important forward step in technology.

This is very confused. The fact that there’s a genuine step forward doesn’t mean it can’t be a bubble.

There was a railroad bubble back in the 1870s in which thousands of small investors were wiped out. That didn’t mean that the railroad wasn’t the future of transport. And the dotcom bubble of the 1990s didn’t mean that the internet had no future.

Symptom number five

So far, the tell-tale symptoms have all been about other people. This final one is about you.

You find yourself starting to panic: have you missed the chance of a lifetime? You can hardly even bear to look at the price of the asset anymore. There’s a moistening of your palms, and a sick feeling in your belly.

It’s as if there’s a magnetic force pulling you in.

But maybe it’s not too late. Maybe there’s still a way to go?

Now you, the sensible person you are, the person who said from the very beginning “this is just a bubble”, find yourself irresistibly tempted – pressured even – to take a punt.

These are the five symptoms.

How many can you see?

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