Excessive euphoria in the stock market should act as a clear signal for the average investor not to put more money into securities or funds. With euphoria, or the excitement of rising stock prices, soon comes the opposite: a market correction of unknown proportions. Recent history in fact shows that the more intense the euphoria, the deeper the correction. The correction might well seem more like a stock market rout that descends into an outright recession or depression than a temporary drawback.
The investor can easily observe several pragmatic indicators that warn of excessive euphoria in the stock market. They should serve to prepare the investor to take defensive action.
Daily news stories:
Daily newspapers begin to feature stories about the great new Bull Market, often with screamer headlines. Television newscasts run specials about investing processes and have guest analysts who tout different methods for viewers to cash in on the boom. Everyone seems to have good things to say about the stock market; naysayers take a back seat.
Stock after stock in favored investing segments of the market reach new pricing highs. A chart of mutual funds will look a lot like stair steps – going up and up. Everyone seems fully invested and cash reserves diminish.
Day traders return as a driving force in daily securities activities. Mutual fund managers begin plowing liquid assets into popular high-priced securities. People who have never traded or invested in the stock market begin plundering savings accounts in order to participate in the action.
Water cooler discussions at work abandon sports statistics for the latest stock market quotations. Like a communicable disease, the fever to invest seems to have infected everyone with whom a person comes into close contact. Everybody wants in on the game, even if they have to borrow money to play.
When the stock market – when traders and investors, actually – become this euphoric, the situation, as has happened again and again, will reach a tipping point. A sudden, surprise sell-out in a troubled segment of the economy will trigger the downturn. The domino effect takes over. Stocks that once traded higher than ever in history now go begging as prices fall, and fall again. Smart traders begin realizing great profits through the process of short selling in time to benefit from a decline in prices.
The cyclical nature of the stock market has once again moved wealth out of the hands of some into the coffers of others.