Here's a quick exercise. Ask a friend or relative with no investing experience to estimate the value of a single Bitcoin right now. Were they close or did they look at you with a quizzical expression? The former is as good a signal as any that the cryptocurrency's value could be about to plummet.
Right now, Bitcoin is dominating headlines around the world. Barely a day passes without its price hitting fresh highs, fuelling discussion over how much money is being made/could still be made from this, or blockchain technology in general. When even those who had absolutely no prior interest in financial matters suddenly have an opinion on a particular asset or -- if we're going to the extreme -- contemplate leaving their job to become full-time traders, you can be fairly confident that we're fast-approaching, if not already in, bubble territory.
A classic example of this would be when Joe Kennedy -- father of US President John F. Kennedy -- disposed of his entire portfolio after a shoeshine boy began talking to him about stocks. Receiving tips from someone with no financial background was, for Kennedy, a clear sign that the market was becoming far too popular for its own good. Days later, the US stock market crashed. It was 1929 -- the year that kicked off the Great Depression.
We're often told that the past can never be a guide to the future. That doesn't mean we can't learn from it. So what else might indicate that Bitcoin's bubble is about to burst?
Speculation is rife
A second signal -- related to that mentioned above -- is when normally rational investors begin speculating by moving away from solid (if unexciting) assets in the hope of becoming ludicrously rich, ludicrously fast. Perhaps they've been lured to the cryptocurrency after learning about the staggering gains made by those who purchased Bitcoin only a few years ago.
Unfortunately, speculation tends to go hand-in-hand with a lack of understanding. I'd go so far as to suggest that only a minority of those now invested in Bitcoin fully appreciate the technology or the potential consequences of governments attempting to regulate or ban it. Even experienced investors buying-in today are simply betting that its price will continue to rise -- a state of affairs not dissimilar to what occurred at the end of the last millennium when anything remotely dotcom related soared in value. We all know how that turned out. Speculation is the antithesis of Foolish investing and a recipe for huge volatility.
A further sign of an impending crash is when dissenting views are shouted down by the majority of market participants -- something you see all the time on bulletin boards dedicated to specific shares. Unfortunately, confirmation bias is quickly becoming rife among cryptocurrency bulls.
The sudden rise in the number of Initial Coin Offerings (ICOs) is another ominous development, particularly as many of these are likely to be fraudulent due to a lack of regulation. In the same way that a host of new companies listing on the stock exchange can signal a market beginning to overheat, the same applies in the cryptocurrency world.
While Bitcoin's meteoric rise could continue, we all know how this is going to end. Whenever someone attempts to reassure you that "this time, it's different", you can be highly certain it's not.
Learn from the...worst
Becoming familiar with the signs of a financial bubble is crucial if you're too avoid catastrophic losses during your stock market career.
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Paul Summers has no position in any of the companies mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.