Nick Goold
In recent months, more traders have started saying that the U.S. stock market may be in a bubble because of the huge rise in AI-related stocks. This talk has been going on for over a year, but it’s getting stronger as prices keep reaching new highs. It’s not only U.S. stocks — gold has climbed sharply this year, Japanese shares have hit record highs and are up over 30% this year, and Bitcoin has had several “bubble” phases after massive rallies.
So what exactly is a bubble, how can traders recognize one, and how can you trade it — or survive it?
What Is a Market Bubble?
A bubble happens when prices rise way above what an asset is actually worth. People buy because they think prices will keep rising forever, not because of real value. Eventually reality sets in, and prices crash.
Examples of past bubbles include:
- The Dot-Com Bubble (2000): Tech stocks soared as people believed every internet company would change the world. When profits didn’t follow, the bubble burst.
- The U.S. Housing Bubble (2008): Easy credit pushed real estate prices too high until the collapse triggered a financial crisis.
Bubbles usually follow the same pattern — optimism, excitement, greed, panic, and collapse.
How to Spot a Bubble
Everyone Thinks It Can't Fall: When people say "it only goes up" or "you can't lose," be careful. This kind of thinking appears near bubble peaks.
Prices Rising Too Fast: When assets shoot up much faster than normal and far above historical values, that's a warning sign.
"This Time Is Different": Every bubble has a story about why old rules don't apply. In the dot-com era it was "the internet changes everything." Now it's "AI will transform everything." These stories justify crazy prices.
Your Friends Are Talking About It: When non-traders start giving investment tips, the bubble is probably near its end.
You can't really know it's a bubble until after it pops. Markets can stay crazy far longer than you expect. This is why you need a trading plan, not predictions.
How to Trade a Bubble
A common mistake is trying to predict the top too early. Bubbles can last much longer than expected, and prices can keep rising even when logic says they shouldn’t. For FX and CFD traders, who usually trade short-term, there are many ways to profit from both the rise and fall — if you follow the market, not your emotions.
1. Following the Bubble (Riding the Wave)
The safest way is to go with the flow until the market tells you to stop.
- Use Simple Trend Tools: A 10-day Moving Average (MA) is a great, simple tool. As long as the market is above the upward-sloping 10-day MA, the trend is strong, and it's safer to keep buying dips.
Gold Daily Chart with 10 day moving average - Entry Signal: Look to buy when the price pulls back down to the 10-day MA, as this shows demand is still strong enough to push it higher.
- Short-Term Profits: The Upper Bollinger Band can act like a temporary ceiling. Consider taking small profits there, then waiting for the price to return to the 10-day MA before buying again.
- Don't Argue: If the price is above the 10-day MA, the trend is up. Don't listen to analysts who say the bubble has to end—follow the technical uptrend until it breaks.
- Exit Signal: When the market closes below the 10-day MA, it's a clear technical break. Exit your long position immediately.
2. Trading the End of a Bubble (Betting on the Crash)
This is high-risk, high-reward trading.
- The Safer Way (Wait for Confirmation): Don't sell until the uptrend is clearly broken. Wait for the price to fall below the 10-day MA or, even better, fall below a major long-term support level (a key price floor).
Gold Daily Chart with 10 day moving average - The Aggressive Way (Selling Overbought): This means selling when the market is way "overbought" (like hitting the Upper Bollinger Band or being miles away from the 10-day MA). The Danger: The market can stay "overbought" for a long time in a bubble. If you try this, you must be extremely disciplined to cut your losses fast if the price keeps rising.
Gold Daily Chart with 10 day moving average and Bollingbands
Surviving and Profiting from Bubbles
Rule #1: Manage Your Losses
Bubble markets move fast and far. You need to protect yourself.
- Always Use Stop Losses: Put your stop in as soon as you enter a trade. No exceptions. In volatile markets, one big move without a stop can wipe you out.
- Cut Losses Fast: When your stop is hit, get out. Don't hope it comes back. You can always enter again later. There will be more opportunities.
- Trade Smaller Sizes: When volatility is high, use smaller positions. It's better to stay in the game with a smaller position than get knocked out with a big one.
Rule #2: Let Your Winners Run
Bubbles create huge moves. Normal profit targets are too small.
- Set Bigger Targets: Instead of aiming for 1:1 or 2:1 risk-reward, target at least 3:1 or larger. You can always adjust later if needed. In bubbles, 5:1 or 10:1 moves happen regularly.
- Use Trailing Stops: Instead of setting a fixed profit target, keep moving your stop loss higher as the trade moves in your favor, placing it below the 10-day moving average during an uptrend. This approach helps you capture large moves while still protecting your profits
- Take Partial Profits: Take some money off at key levels but keep part of your position running. This feels good psychologically and keeps you in for bigger moves.
- Don't Exit Too Early: The biggest mistake in bubble markets is getting out too soon. If your indicator says stay in, stay in.
Rule #3: Stay Flexible
Your opinion doesn't matter. The market doesn't care what you think.
- Don't Fight the Trend: If you think something is overvalued but it keeps going up, your opinion is wrong. Trade what you see, not what you think should happen.
- Be Ready to Switch Sides: If you were long during the bubble and your signal says sell, go short. No ego. No "but I was just long yesterday." The best traders change their minds when the market changes.
- Follow Your System: Make a simple plan before you trade. When price does X, you do Y. Then follow it. Don't let fear or greed change your plan mid-trade.
Remember Famous Traders Got Timing Wrong: Michael Burry shorted the housing market over a year early and almost went broke before being proven right. He survived because he had huge capital. Most traders don't. Don't try to be a hero—follow your signals.
Common Mistakes to Avoid
- Calling the Top Too Early: Just because something looks expensive doesn't mean it won't go higher. Wait for your signal.
- Adding to Losing Positions: Never average down in a bubble. If you're wrong, get out. Don't throw good money after bad.
- Trading Without a Plan: Winging it in volatile markets is a disaster. Know exactly what you'll do before you enter.
- Ignoring Your Stops: When your stop is hit, you're wrong. Accept it and move on.
- Listening to Others: Your brother's friend who made money on Bitcoin doesn't know if it will keep going up. Trust your system, not tips.
- Revenge Trading: Lost money? Don't immediately jump into another trade to "get it back." Stick to your plan.
The current markets might be in bubbles, or they might just be strong trends. It doesn't matter. Trade what's in front of you. Follow your signals. Protect your capital. The traders who survive and profit aren't the ones who predict the future—they're the ones who adapt to whatever the market does.
