The first ever investment bubble in recorded history dated nearly four centuries back in 17th century Holland (Netherlands). The bubble was of a flower , Yes a flower!!! namely “Tulip” with no such major use.

The crash was neither a major economic event nor it affected Holland’s economy but the rise of a commodity with no future cash inflows and then severity of price fall was surprising. The price went up more than 20 times within only a month, and then in February 1637 the prices felt like a waterfall.

Let’s see in detail How actually it happened. In 1593 tulips were brought from Turkey and introduced to the Dutch (Native to Netherlands). The novelty of the new flower made it widely sought and fairly priced. After a time, the tulips hit with a virus known as mosaic, which didn't kill the tulip but altered them causing "flames" of colour to appear upon the petals. The colour patterns came in a wide variety, increasing the rarity of an already unique flower. Thus, tulips, which were already selling at a premium, began to rise in price according to how their virus alterations were valued or desired.

Now everyone began to deal in bulbs and in 1634, speculators began to enter the market speculating on the tulip market. Soon, prices were rising so fast and high that people were trading their land, savings, and anything else they could liquidate to get more tulip bulbs.

Somehow, the originally overpriced tulips enjoyed a twenty-fold increase in value - in one month!!! As it happens in many speculative bubbles, some prudent people decided to sell and book profits. This resulted in progressively lower and lower prices causing people to panic and sell regardless of losses.

Dealers refused to honour contracts and people began to realize they traded their homes for a piece of greenery that created panic. The government attempted to step in and halt the crash by offering to honour contracts at 10% of the face value, but then the market plunged even lower, making such compensation impossible. Everyone suffered from the crash.

MAJOR Reasons of this crash:

1.HERD MENTALITY (FOLLOWING THE CROWD):

Herd mentality is characterized by a lack of individual decision-making or thoughtfulness, causing people to think and act in the same way as the majority of those around them. We do things because everyone else seems to be doing it, even when there are no good reasons for doing so. A herd mentality relates to instances in which individuals descend to the same or similar investments, based almost solely on the fact that many others are investing in those stocks.

RELATE IT WITH STOCK MARKET:

You heard everyone saying that the bull market will stop soon. You looked at your charts with your technical analysis tools and found nothing bearish. You looked at more charts and found some bullish clues. But because everyone was saying that the bull market would come to an end, you sold all your long positions. The outcome of the market does not matter, whether it continued to rise or fall. You have already surrendered to the herd mentality bias because you followed the herd instead of your analysis.

TRADING/INVESTING RULE TO SHIELD FROM HERD MENTALITY:

Don’t follow herd behavior of investors.

The best traders are often alone, because they listen to their own analysis, and ignore the voices of the masses.

Generally, when all people start buying (Mass Psychology is bullish) then it is time to top out.. So, does It mean to always go against mass?? That is not the case.

The masses might be right, or they might be wrong. But you are probably wrong when you think that something is right only because everyone seems to say so. Never read market commentaries or listen to market news when you trade.

2.IRRATIONAL BEHAVIOR:

Looking at a price, we would be amazed at the craziness of people to trade something physical which didn’t produce any earnings and cash flows. No one wanted the tulips, only the profits- it was a phenomenon of pure greed. Investors tend to think that there will always be buyers whom they can sell at a higher price than their cost. It looks true because many have been doing it, but this is obviously incorrect. When the prices appreciate beyond the affordability of investors, there will be no buyers and prices come crashing down.

RELATE IT WITH STOCK MARKET:

Look at the multiples in 2007-2008 just before the market crashed.
There were companies trading at a P/E ratio over 100 without making a single paisa in profit in the dotcom era.

TRADING/INVESTING RULE TO SHIELD FROM HERD MENTALITY:

Buy best Shares to buy :
Loss of rationality on the part of the investors. In the stock markets, there are good companies that are overpriced and there are worthless companies (monkeys) that are overpriced. Always trade or invest in best stocks to buy, Don't be fool to pay absurd prices for garbage stocks because you think that a greater fool will appear in the future, make sure that at least you don't buy a monkey useless company in stock market. Don't buy such companies whose products or services you don’t understand, companies should be able to make new highs on market recovery.

3.GREED (Buying after major up move over as you cannot resist more seeing rising Prices)

Market moves according to greed and fear cycle. Market generally moves opposite to Mass Psychology. Though the company results comes once a quarter or any fundamental news or big changes comes once a while still price keeps changing every movement and many times sharp moves comes, those moves comes due to human psychology i.e. greed and fear cycle. Markets always make new highs and increasing number of people around you discuss about stock market. But fear starts when even pan ka gale wala start discussing stocks.

RELATE IT WITH STOCK MARKET:

Many times, we don’t enjoy the rally of some stock from bottom but we buy it on higher side using breakout strategies, and soon we end with the stock in buy on highest Price.

TRADING/INVESTING RULE TO SHIELD FROM GREED MENTALITY:

FOLLOW MONEY MANAGEMENT

You bought when all bought, you bought useless thing, you bought as you cannot resist seeing rising prices but still if you bought in limit, you can save yourself from being Bankrupt when you were wrong. We cannot think it is not worth buying just because it has given up move for trading or investment but we must buy qty. whose fall we can bear.

Author's Bio: 

ABJ Desk (Multibaggers.co.in): We are a team of Stock Market Research Analyst, Traders, and Tutors; protecting capital and increasing the wealth of clients.

To learn Technical Analysis with Money Management and Trading Psychology contact us.