Hello friends, I am Laxman Sonale, In Today’s article, we see the stock market bubble from chapter 10 of the book Stock to riches. In this chapter, the author explains the different types of thinking of participants in the markets. and how the government thinks, and how the system thinks, as well as how operator the benefits of any situation.
What are we learn from this Blog?
if you read this blog carefully then you realize how the system works, and how people play the game of the stock market bubble formation, and make the money. If you are a retail investor, then you definitely avoid this game, how to avoid detail, in this blog,
so let’s start
Chapter 10:- The Stock Market Bubble formation
In this chapter, the author Parag Parikh talks about the financial bubble that happened in history. Their cause ad psychology of every participant. so let’s understand one by one the reason for their bubble formation and bubble bursts.
In starting the author says, ” The Stock Market are fascinating because they are so unpredictable furious activity is followed by long periods of lull. Many a fortune is made and lost. the Greed and Fear of participants make the stock market volatile. (The Stock Market Bubble)
The one who can understand this and in turn exploit it is easily the master. Stock markets are known for their intermittent bubble. to understand who and what causes them, we need to ascertain how the system works and what drives the participants. Systems Vagaries of the stock markets.”
then the author talks about how the system thinks about it.
System Thinking:-The Stock Market Bubble
In this, the author says, ” A system is that which maintains its existence and functions as a whole through the interaction of its various parts. The human body is a perfect example of a system. It consists of different parts and organs each acting separately yet all working together and each impacting the others.
Similarly, all around us, there are systems and systems within systems. System thinking is looking at the whole picture, the different parts, and the interconnection between the parts.
It thinking in circles, in loops rather than in straight lines. the parts of a system are all connected directly or indirectly. The action of one part affects the other and that other responds to the new influence.
The influence then comes back to the first part in modified ways, making a loop, not a straight line. This is known as the FeedBack loop.” (The Stock Market Bubble)
then the author gives the example of our hunger to understand the feedback loop
Hunger is a good example of this. When you feel hungry, you want to eat. so you eat as much as you need to satisfy your hunger. Once your hunger is satisfied you stop eating.
your hunger influenced your craving for food and in turn the amount of food. you ate influenced your hunger. it looks like one action but actually, it is a loop. it would be only one action if you knew exactly how much food to eat to feed your hunger and you ate that quantity of food.
When two parts are connected the influence can go both ways, like a telephone line; if you can dial a friend he can also dial you.
Feedback is the output of a system reentering as its input, or the return of information to influence the next step.
Feedback is fundamental to systems. there are two types of feedback loops.
When changes in the whole system return to amplify the original change and this amplified change goes through the system producing more change in the same direction.
An example would be a snowball rolling down the hill. it collects snow as it rolls and becomes larger and larger until it eventually becomes a boulder.
When changes in the whole system return to oppose the original change and so dampen the effect. A balancing feedback loop is where the change in one of the systems results in a change in the rest of the system. that restrict, limit or oppose the initial change and keep the system stable, or else the reinforcing feedback would break the system. (The Stock Market Bubble)
Feedback is a circle. It takes time to travel round in a circle and so the effect can appear sometime after the cause. when there is a time delay between cause and effect and we assume there is no effect at all, we may be surprised when the effort suddenly happens.
What we do now will affect our lives in the future when the consequences come around again. We do not see the connection and we blame prevailing conditions but actually, the roots lie in our own past actions. We mold the future by our present actions.
Very often the most critical point of leverage in any system is the belief of the people because it is these beliefs that sustain the system.
The stock market is one such system and it is its beliefs and the behavior of its. Various participants from time to time shape their progress.”
then author explains each participants psychology, including governments, regulators, stock exchange, brokers, banks, companies
The Psychology of Stock Market Participants:-
At this point, you know each participant’s aim in the stock market, and how they think
in this author says, ” understanding the psychology of the participants is the key to knowing how they will behave when they are gripped by fear and greed. he who understands this psychology is able to manipulate the markets by using the different participants at different times.
Now let’s see what each one wants from the markets.
At this point when the world has become a global village and each country wants to attract foreign capital, governments need booming markets. (The Stock Market Bubble)
Stock markets are the barometer of an economy. they send positive signals to foreign investors when they are in a bull phase.
Booming stock markets create confidence and spur the governments to go ahead with their economic policies. No government likes depressed stock markets.
Regulators are appointed by the government, the regulator also likes booming stock markets.
A rising market is evidence of good government it also results in additional revenue in the form of higher transaction of services charges due to the increase in turnover.
They facilitate stock transactions. during boom periods, incomes skyrocket, by way of transaction charges from brokers, listing fees, etc.
in a bull market, the clientele increase and so do business opportunities. this results in higher incomes for the brokers.
Their business increases with soaring stock markets as opportunities open up in lending against stocks, margin trading, depository, and custodial business. etc.
The feel-good factor drives investors to banks for various financial services.
Rising markets lead to higher stock prices, the net worth of owners increases, and companies can map up more capital for expansions. Financially healthy companies are able to attract and retain good talent and keep their shareholders happy. (The Stock Market Bubble)
Higher stock prices mean increased net asset value rising markets attract more investors which means more money under management fees. they are also able to come out with different kinds of funds to satisfy every requirement.
The media plays a pivotal role in spreading information. an increase In investors means increased viewers/readers, which translates into increased advertisements revenue.
The lure of quick money draws investors into a bull market. Day traders become very active as they are rewarded with easy gains.
He is the smartest and shrewdest of all. he is aware that the bull run psychology creates the bull run. He knows the system, he understands the psychology of the participants and he has the ability to exploit that for his own benefit.
He is the king-maker who uses his knowledge to win over investors, brokers, and company management.
the author explains how we make a bubble in the market.
Making the Bubble:-
in starting this point, the author gives the quote
: ” Whoever can supply them with illusion is easily their market.” – Guston Le Bun
so the author gives three points of making bubble.
1) Stock Price:-
At this point, the author says ” The fulcrum of the stock market is the stock price. the management of companies is the biggest beneficiary of a price increase and it is in its interest to keep stock prices high.
Anyone who promises to boost line prices easily becomes its master.
The operator understands the weakness very well, he tells the management that its company stock is undervalued and convinces it that he can take it higher. in most cases, he is a broker or an investment banker, which gives him the credibility of knowing the stock markets.” (The Stock Market Bubble)
then comes the role of the second point
2) The Deal:-
The management gives the operator some stocks at the current low price and a predetermined amount to rig the stock. the operator uses the money for his stock market operations while his profits come from a portion of the stock he is given at the beginning, which he sells when the price goes up.
A fixed amount of performance fees is also given to execute the deal. Over and above that the operator makes money by way of trading on his own account during the rigging process.
the third point is one circular trading
3) Circular trading:-
This author explains step-by-step circular trading.
Step-1:- The operator has his own band of brokers who specialize in such operations. the circular trading starts, Broker-1 sells shares to Broker-2 who in turn seel broker-3 who then sells to broker-4, and so on.
As the shares change hands the price increase. thus reported volume. when this data reaches investors they think that since the stock is moving something must be happening. (The Stock Market Bubble)
Circular trading picks up momentum and the stock price and volume increase, the referring loop is created. Even if there is pressure to sell the operator absorbs, it with the money given to him by the management.
If the conditions are bullish the operator and his band of brokers also, absorb the selling by taking their own positions.
This creates artificial scarcity and the reinforcing loop becomes stronger. see figure to understand the circular trading process.
Creating the Reinforcing Loop:-
At this stage, the manipulators can not exit. they are making the bubble, so they need to support the price, or else the reinforcing loop will break.
the Stock needs to get its momentum before it can stand on its own. So a fund manager of a mutual fund or an institutional investor is roped in to join the inner investment adds credibility to the stock.
Investors are lured by the entrance of these investors. This helps the rigging the gives credibility to the stock.
Now the stock has got its feet. Regular Volume data and the rise in price attract investors. Saliency heuristic is at work. the rise in stock is seen as a positive turn in the fortunes of the company.
Slowly the stock becomes newsworthy. Stories about the company, its growth potential, restrictions, and so on appear in the stock market, journals availability heuristics at play.
All available information on the company is positive. the recall value for the stock gains prominence and more investors start buying. (The Stock Market Bubble)
The seed of Greed is sowed. With each price rise, demand for the stock increases, and other players such as retail investors join the game. fundamentals and valuations take a back seat.
The initial operator and his band of brokers at this stage do not do much except plant stories in the media, generate excitement about the stock by way of research reports, and convince another intermediate who in turn recommend the stock to their clients.
Essentially, their job is done. the stock is on autopilot. the bubble starts ballooning. at this stage, the manipulators are able to exit.
the net is spread, more stock market participants enter the fray. Banks and private financiers look for lending opportunities. the stock enters the list of stocks against which banks will give an overdraft facility.
this further enhances the credibility of the stock the stock builds huge volumes as genuine buying and selling take place.
Enter the media. Stock price movements are flashed on tv screens ad analysts recommend it at investment debates.
the stocks soar further on inflexibility as more and more investors enter the market, afraid that they will miss the bus. this herd mentality pushes the stock still further. Now with greed in the driving seat representative heuristic comes effect makes investors feel that the market is undervaluing their stock and they become more confident of their holding.
they become salesmen for the stock and recommend it to their own friends, and relatives. Each person becomes an expert in his own sphere of influence. the initial operator then exits and move to other stocks in the same industry where representative heuristic is at play. (The Stock Market Bubble)
the bubble is for real and the reinforcing loop is strong. all the participants in the market are happy, as each one is a winner. Between the cause and effect, there is an interval, the duration of which no one can predict. the balancing loop has to come up to play to correct the system is to be stable. nobody can predict when that will happen but happen it will.
The severity of the balancing loop is directly proportionate to the severity of the reinforcing loop.
then lastly the author explains how the bubble burst,
you can read this in this book, buying this book, from the following link
so this is all about the stock market bubble from book stock to riches.