Many Clever People Don't Understand Bubble Theory

[frugalista]

Been thinking recently about a lot of people I know. They are all very bright people with plenty of knowledge and understanding about all sorts of stuff, and generally very sorted lives.

But, when it comes to market bubbles and cycles, it all seems to be a big nightmare for them. They consistently sell (or fail to buy) at the bottom and buy (or fail to sell) at the top. Again and again. Not just with houses, but stocks and shares too. Even those who've lived through bubble after bubble.

Why is this?

Some starters, off the top of my head:

1- Judging what to do on the basis of recent evidence is normally a good strategy in life, but in markets it can be bad.

2- Listening to anecdotes and advice from friends and family is normally a good strategy in life but in markets it can be bad.

3- In life, it is rarely necessary to look at the historical picture as recent information is usually better, but in markets the historical picture is very important.

4- In life, it is often a safe and beneficial strategy to do what everyone else is doing, but in markets the reverse is true.

5- The theory of bubbles is quite subtle. The idea that there can be speculative as well as real demand and this can vanish when sentiment turns. It is a rather non-linear complex system. You can get through most things in life easily without understanding complex systems.

comments / additions?

frugalista

[StainlessSteelCat]

Great list - frugalista. My couple of additions.

Everyone loves the idea of something for nothing or more charitably a bargain or a great investment.

Most people think they are special/smart/lucky enough to deserve above.

[apom]

Its all very simple for the Bubble theory..

houses rise in value and some make a great deal of money from it.

but if you take it that all houses are owned then the current owner has provided all of the profit for that house to all of the previous owners. His repayments covers the surge in prices. Money didn't come from no where, it came solely from the current owners.

So if they are hopeing to make a profit all they have to do is find someone to sell it to for more then they paid.

For the market to keep going up you need to find someone to buy it from you for more then you paid..

Now.. Eventually all speculative marets end up with someone having paid too much with no one else willing to buy it from them at a profit..

but don't worry..

There are a lot of people waiting to pay a lot less..

Just hope that you havent overstretched yourself too far..

[justanewbie]

5- The theory of bubbles is quite subtle. The idea that there can be speculative as well as real demand and this can vanish when sentiment turns. It is a rather non-linear complex system. You can get through most things in life easily without understanding complex systems.

comments / additions?

frugalista

<{POST_SNAPBACK}>

First class observations.

Thank you.

I suppose most of us live our lives facing fixed prices in the shops.

Our only experience of a negotiable, fluid, speculative market comes

two or three times in our lives when we buy/sell a house.

And so easily, we are sucked into something which is not quite what it

appears to be.

This time round, I am treading very carefully - so far, all has gone well.

[liquid]

Been thinking recently about a lot of people I know. They are all very bright people with plenty of knowledge and understanding about all sorts of stuff, and generally very sorted lives.

But, when it comes to market bubbles and cycles, it all seems to be a big nightmare for them. They consistently sell (or fail to buy) at the bottom and buy (or fail to sell) at the top. Again and again. Not just with houses, but stocks and shares too. Even those who've lived through bubble after bubble.

Why is this?

<{POST_SNAPBACK}>

An answer perhaps lies in your own train of thought, i.e. ‘…and generally [they have] very sorted lives’. When a bubble forms it is hardly noticeable by those that do not have an interest in it. Why should they, for they are content with their lot. Yet when a bubble rises, and thus, becomes noticeable, some of these people suddenly feel vulnerable. The reasons for this are open to conjecture. I guess they feel they will miss out. In what exactly, again, is anyone's guess. Thus, they buy, when really, they shouldn't have bothered.

I’m not sure if there are any winners or losers in market bubbles. There are some, who having bought at the bottom whether out of foresight or luck, also appear to lose, in my opinion.

[penbat1]

It requires a bit of lateral thinking. Many people may be accademic or technical geniuses but have little ability to think something through independantly.

[since the beginning]

people can be intelligent individually,

but once they surrender to the crowd, and become unthinking and unblinking members of the herd, their emotional and intellectual ability sinks to the lowest common denominator. they are easily led, and make stupid blunders, simply because they feel save copying the behaviourof those around them

<{POST_SNAPBACK}>

Your right I don't agree in violence in any shape or form. But if my mates are beating the hell out of someone I will normally join in with a few kicks to the head etc.

Edited September 16, 2005 by since the beginning

[Clouseau]

I'd suggest it's to do with the 'recent experience' bit - this tends to shape one's sense of what is 'normal' (eg recent house market), & it's difficult to disengage from this & take a more objective, long term view that allows for a radically different scenario; I recently read Robert Prechter's excellent book 'Conquer The Crash', which deals at some length with this phenomenon - you might want to check it out ..

[munro]

First class observations.

Thank you.

I suppose most of us live our lives facing fixed prices in the shops.

Our only experience of a negotiable, fluid, speculative market comes

two or three times in our lives when we buy/sell a house.

And so easily, we are sucked into something which is not quite what it

appears to be.

This time round, I am treading very carefully - so far, all has gone well.

<{POST_SNAPBACK}>

This is also a first-class observation...most of my working life has been spent around businesses which operate in such markets, and most of my working life I've been self-employed (or temping when I've been skint). One firm I temped at, the person I was working with had an accident so I was effectively landed with her job; at about 60% of what they were paying her. I said fine, I'll do the job, but I want 40% more - still about 75% of her pay. They said no so I walked. Kind of amused to see recently that the firm went bust, although sad to see its pension scheme also went belly up.

Once its pointed out that the vast majority of people with regular jobs etc have so little contact with these sorts of markets, its obvious, but it had never occurred to me. I think this does go a long way to explaining why people take house prices as akin to shop prices, as if they have some sort of authoritative basis. I know I tend to assume that shop prices are "authoritative" and reflect in some way cost + fair profit, although obviously it isn't quite so straightforward. Maybe part of the present problems is that bargaining isn't a feature of everyday life. If it was it would make people think harder about what they pay...although maybe internet shopping will bring some of that back?

Good thread!

[Elizabeth]

Your right I don't agree in violence in any shape or form. But if my mates are beating the hell out of someone I will normally join in with a few kicks to the head etc.

<{POST_SNAPBACK}>

You think you won't, but there is some very interesting research to suggest that maybe you will if your mates are kicking with authority!

The Milgram Experiment:

http://en.wikipedia.org/wiki/Milgram_experiment

[Guest prudence]

It may be that many so-called intelligent people simply do not want to understand or even consider the bubble theory because it would then make them realise that at some stage they are going to be worth less than they had hoped...

[E Powell]

I think most people read the scum/times that brainwashes them.

Enbough said.

[dogbox]

Bears are also guilty of crowd mentaility.

I know quite a few of them. If I say 'have you thought about buying in Berlin' for example, to a Man they dismiss the thought. Its just too uncomfortable.

They instinctively and as a crowd justify thier thought patterns with the same old bear -crowd mantras:

"I wouldnt buy there, Germans dont buy property"

"Ill keep my powder dry and stick with cash for now (read, forever)"

"Germany is in the grip of recession, I cant see it ending"

"The Political landscape is unsettled"

If you unpick this language you soon realise its all down to FEAR. The bear crowd cannot see beyond thier own safe little world.

THE BEAR CROWD WOULD ALSO HAVE AVOIDED UK B2L IN THE EARLY NINITIES BECAUSE THE FEAR - FACTOR OVERRODE ALL OTHER CONSIDERATIONS.

[Starcrossed]

Bears are also guilty of crowd mentaility.

<{POST_SNAPBACK}>

Sure. When the bears have been in the ascendancy for 5 years, the bulls will be the contrarians.

The ability to see through a bubble must be difficult to those that think in straight lines.

Perhaps a common denominator of those on this board is that whatever differences we have on politics etc we are generally emotionally intelligent and pretty good at expressing ourselves.

This capacity may the factor that move us beyond many of those with big brains that don't appear able to see the reality of bubbles. Hope that does not sound too smug.

Or maybe many people just don't care - they do not have an appreciation of the value of money and *shrug* their shoulders because it does not seem real to them.

[frugalista]

Bears are also guilty of crowd mentaility.

I know quite a few of them. If I say 'have you thought about buying in Berlin' for example, to a Man they dismiss the thought. Its just too uncomfortable.

<{POST_SNAPBACK}>

When the facts change, I change my opinions. In a few years I may well be a UK property bull.

Dunno about the German housing market, but generally I am bullish on Germany. High level of education and technical expertise, high savings rate, low price earnings ratio etc. etc. -- the facts are clear.

Berlin is a great place to live, my sister lived there for 4 years and I visited several times. One thing about it is it is not known as a great centre for jobs, which may be why it was cheap as chips to live there. But that could easily change.

I guess I am just generally a contrarian.

frugalista

[LazyDay]

Been thinking recently about a lot of people I know. They are all very bright people with plenty of knowledge and understanding about all sorts of stuff, and generally very sorted lives.

But, when it comes to market bubbles and cycles, it all seems to be a big nightmare for them. They consistently sell (or fail to buy) at the bottom and buy (or fail to sell) at the top. Again and again. Not just with houses, but stocks and shares too. Even those who've lived through bubble after bubble.

comments / additions?

frugalista

<{POST_SNAPBACK}>

Economic and financial cycles are stochastic cycles, that means their length is not a predefined constant, but rather a random variable. This, in turn, means that even if you know you are in the middle of a boom/recession, the next turning point is impossible to predict in advance. No one, not even Alan Greenspan, can do that. He was wrong many times and I doubt anybody can call him dull or lacking the recourses or experience or knowledge. If bubbles (cycles) were so predictable in their growth and death, there would not be any.

[Duplex]

I suppose most of us live our lives facing fixed prices in the shops.

Our only experience of a negotiable, fluid, speculative market comes

two or three times in our lives when we buy/sell a house.

Very astute point, and as someone once said mankind didn’t necessarily evolve to make good decisions.

[Phaedrus]

Berlin is a great place to live, my sister lived there for 4 years and I visited several times. One thing about it is it is not known as a great centre for jobs, which may be why it was cheap as chips to live there. But that could easily change.

frugalista

<{POST_SNAPBACK}>

A few years back that was true. Remember it is now the Capital city which has brought a lot of work and investment in infrastructure, so more jobs. The cheapness is an historical throwback. When it was a divided city the housing stock was pretty much static. This would have enabled landlords to charge high rents, as there was not so much choice to go elsewhere. The Government introduced very strict rent controls to mitigate against this. This culture has not gone since the wall came down.

Interesting how a Government can actually help its citizens if it really wants to(compare the Berlin experience to that of the current UK Government).

[Smell the Fear]

I think most people read the scum/times that brainwashes them.

Enbough said.

<{POST_SNAPBACK}>

That's the crudest academic quote I've ever read. Where does this Enbough work? Surely not one of our fine red brick universities. Must be one of the ex-polytechnics.

[Jason]

Has anyone got a copy of the cycle chart? Dr Bubb posted an image on one of his threads a while back (and I can't find it).

It was a S wave image, with words such as - hope - optimism - euthophria - denial - anger ... etc

Anyway, I want a nice graph that I can print off and put on the wall where I work - where I keep lots of daily usful info!

[mad'un]

Been thinking recently about a lot of people I know. They are all very bright people with plenty of knowledge and understanding about all sorts of stuff, and generally very sorted lives.

But, when it comes to market bubbles and cycles, it all seems to be a big nightmare for them. They consistently sell (or fail to buy) at the bottom and buy (or fail to sell) at the top. Again and again. Not just with houses, but stocks and shares too. Even those who've lived through bubble after bubble.

Why is this?

Some starters, off the top of my head:

1- Judging what to do on the basis of recent evidence is normally a good strategy in life, but in markets it can be bad.

2- Listening to anecdotes and advice from friends and family is normally a good strategy in life but in markets it can be bad.

3- In life, it is rarely necessary to look at the historical picture as recent information is usually better, but in markets the historical picture is very important.

4- In life, it is often a safe and beneficial strategy to do what everyone else is doing, but in markets the reverse is true.

5- The theory of bubbles is quite subtle. The idea that there can be speculative as well as real demand and this can vanish when sentiment turns. It is a rather non-linear complex system. You can get through most things in life easily without understanding complex systems.

comments / additions?

frugalista

<{POST_SNAPBACK}>

I think it is because, as with so many other things in this world / this life - some people no matter how "intelligent" or experienced they may be, do not WANT to acknowledge certain inescapable truths. Head in the sand approach does not distinguish between IQs. Bubbles and cycles can be analysed and intelligently worked out, but everyone surely has a gut feeling for these things. My theory is that once the gut feeling starts to trouble, then the intelligence is switched off. People deliberately do not "work it out" and that way they can feel comfortable(ish)

-Just my thoughts

[frugalista]

A few years back that was true. Remember it is now the Capital city which has brought a lot of work and investment in infrastructure, so more jobs. The cheapness is an historical throwback. When it was a divided city the housing stock was pretty much static. This would have enabled landlords to charge high rents, as there was not so much choice to go elsewhere. The Government introduced very strict rent controls to mitigate against this. This culture has not gone since the wall came down.

Interesting how a Government can actually help its citizens if it really wants to(compare the Berlin experience to that of the current UK Government).

<{POST_SNAPBACK}>

Is the ex-communist PDS still in office in the Berlin city government?

http://www.guardian.co.uk/international/st...,623299,00.html

frugalista

[frugalista]

more thoughts....

Some clever people understand bubble theory, just don't believe it applies to market X. Or don't believe it applies today. Fair enough. Everyone has to judge the evidence for themselves.

But some clever people apparently just literally do not understand the elements of the theory. How can the price of something go up or down by such a lot for no good reason?

It's like Darwinian natural selection for example. Some people just do not get the fundamental ideas. Just too subtle / abstract perhaps?

frugalista

[Starcrossed]

The similarity of the theory of bubbles to the theory of evolution is a good one to dwell on.

They are both theories but are made self-evident by the fact they create the very reality we live in. To those that agree in their existence, their truth is so self-evident that it seems incomprehensible that anyone could not see the same thing.

Perhaps those that don't 'get it' just can't see the wood for the trees. They find details that trouble them (ie the fact that bubbles cannot be timed mathematically, that it is difficult to see evolution in 'real time') that block the actual understanding of the truth all around them.

Edited September 16, 2005 by Starcrossed

[frugalista]

Perhaps it is simply because no one has explained it to them in a clear no-nonsense way?

frugalista