Picture of a bubble

Inspired by the discussion below.

(Click on image to enlarge)

This is a decade chart of the stock for the company Ciena. I have a friend who worked for that company in the late 90s and was a multi-millionaire on paper for a brief period, but like many others in the tech industry, lost the value of his options in the crash. Ciena is representative of the rise and fall of many companies' stocks in that era. I could find at least a few hundred companies with similar charts.

Note the parabolic nature of the spike from late 1998 to late 2000. It's not simply a linear increase in price. Rather, the price increases faster and faster till a blowoff top results.

The price before the spike was as low as $25. After the spike, the price has been below $50 for more than five years. The lowest price after the spike was nearly $10. It's hard to say what "fair value" is, if there is such as thing at all, without looking at the fundamentals, but we can approximate it at $20 or so. That means that the bubble 'falsely' raised the price by a factor of 50. This is a dramatic illustration of just how out-of-whack prices get during bubbles. They're not simply high, but rather, shockingly, disgustingly, beyond-belief high.

Would anyone who believed during the period of the spike that the stock market was in a bubble want to short this stock? Remember, nobody knows how long the bubble will last nor how high prices will go. We can look back in time using the chart and see that the price peaked in late 2000. But at that time, we wouldn't know. We can't predict the future. What if the spike had continued for another six months?

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It reminds me of my own lost paper millions from that time...

It's not parabolic, it's

It's not parabolic, it's exponential... if you look at it on a log chart, which is more appropriate for stock prices, it will look :
much less dramatic

CIEN moved from $30 in October 1998 to a pick around $1000 in October 2000, and then back to $20 in October 2002. That was the biggest swing... it grew at 15% per month for two years, then fell at 15% per month for two years. That is huge by all standards, but it's simple to call it a bubble afterward, I don't think it was necessarily obvious at the time.

If it's so obvious, pick CCI, it was at 1.15 in August 2002 and is now at 42.75, that's a 3600% gain... it lost the same from the 2000 pick to 2002.

It's not parabolic, it's

It's not parabolic, it's exponential...

Details, details... :)

It looks like the right hand side of a parabola to me. If you say that fitting the curve would actually yield an exponential function, I'll take your word for it. My point was only that bubble dynamics result in the price that has a large positive 2nd derivative. It becomes very difficult to predict price with any precision at any future time.

Those are impressive numbers, but I still say that you could have justifiably called it a bubble while it was happening, taking the industry as a whole and the mass psychology associated with it. Ciena was once valued at close to $100 billion dollars. That discounts continued massive growth into the far future. While this was wildly optimistic for a good company like Ciena, every other internet/tech company was similarly valued with the future shiny and green. Even mere websites like thestreet.com had multi-billion dollar capitalizations. Everyone was predicting a rosy future for every internet/tech company. There was an analyst who projected Cisco's valuation to be greater than the entire GDP of the US a few years into the future. This is bubble psychology.

My point was only that

My point was only that bubble dynamics result in the price that has a large positive 2nd derivative. It becomes very difficult to predict price with any precision at any future time.

Future stock prices are not predicted by past trends.

No doubt

And I knew you were going to respond with that. I don't mean to imply that the future can be exactly predicted. During a bubble, valuation and fundamentals get thrown out the window.

What I mean is that, for someone who believes a bubble exists, it becomes impossible to pick an entry point for shorting, or to realistically determine upper bounds for potential losses after taking a short position. In normal times, the "confidence interval" for such parameters might be a factor of two ("I could lose double what I hope to gain") whereas during a bubble, it would be measured in magnitudes ("I could lose my house, my car, and my underwear whereas what I gain will be a small chunk of change").

You could buy a put...

You could buy a put...

That's what I recommended,

That's what I recommended, remember?