Speculative manias are not new. They've been around for centuries, and who knows how many other speculative manias have happened through the course of history that were never recorded. I prefer to learn about the results of these manias, how to identify them, and what actions should be taken, or not taken in order to minimize my risk. The root of the problem in these events is misjudgment in a variety of factors.
You could simplify things by saying "don't be an idiot and partake in these events" but let's be honest, it's going to fall on deaf ears.
I prefer to break down the reasons that people partake and try to identify traits that are common. Then I like to think of how I perceive these events and what misjudgment I make on a regular basis that is exposing me to risk.
I'll probably be taking aim a lot at Crypto in this as well as the overall tech market in equities. That is where I see the most amount of misjudgment. For more info on how these markets form check out a previous article, I wrote here.
Memory Limitation
Manias tend to form every 10-20 years. I think there is a reason for this. It allows for a new generation of people to enter the markets who haven't been bitten by previous bubbles popping in their faces. Our memory is much more vivid when attached to emotions. When the emotions are simply not there because we haven't experienced it, we either do not remember these events taking place, or have very foggy memories of them. Without doing research, you may have no idea what happened in even the last crash.
With the influx of new investors and the huge weighting of millennials, you are seeing this misjudgment take place in front of our eyes. They lived through the tech boom, and the great recessions, but I'd say most of those people (like me) were not affected by these events. I vaguely remember the great recession, but it didn't impact me much other than seeing angry people leaving offices on wall street after getting a pink slip.
When you compare that to other people who were fully invested at this time, they probably still have some semblance of the memory of the pain they felt after seeing massive drawdowns. If you understand the market can go down in a huge way, you might make better decisions, such as having a larger weighting of cash to deploy when the market goes down versus buying 1000 PE stocks and hoping the "rally continues."
Vividness and Recency
This is very closely attached to our memory limitation above. We are more influenced, remember, and think about things that have happened recently and that we see on a regular basis. We see "bitcoin millionaires," "Tesla Gamblers", Cathie Wood's ETF's all the time and it keeps it top of mind.
When we are bombarded with people with little or no experience investing in living in mansions and driving 500,000 dollar cars we associate this with things like bitcoin. We overweight the positives of what is happening in these environments and underweight the history of how these events usually end. This works in bear markets as well, we overweight how bad things look, we think they will never get better, but if you look at history this is rarely the case.
Social Proof
People love to be a part of a group. When all your friends are doubling their money in a few week's time, it becomes hard to stay away from joining them. Unfortunately, the allure of social proof is so strong, it can cause our decision-making to be heavily distorted when trying to attain it.
You have 4 buddies who have all turned 500 bucks into 1000 over the last month. They talk to you all the time about how you're missing out on "ez money" and that you need to get in. On the one hand, you know this sounds too good to be true. But on the other, you just want to see dollar bills falling around you. In the end, your FOMO overtakes rational thought and you throw money at the investment not realizing you are at the tip of an epic bubble. It pops, and your 500 dollars end up being worth 50 bucks. You swear off investing forever....
Authority
"In the question of science, the authority of a thousand is not worth the humble reasoning of a single individual." - Galileo. Boy was he right, but I think you can substitute science with many words and it still holds true.
This is an idea that is pervasive in our world. People with lots of viewers, Twitter followers, YouTube subscribers, etc. have a lot of influence. They can say whatever they want, right or wrong, and their followers have a very good chance at taking their word as the truth even if there is zero evidence.
If you follow financial markets, you probably have your favorite analysts or talking heads. You might even have an odd infatuation with Elon Musk or the Winklevoss bros. If these people say something, their authority can literally move markets. Look at how Elon Musk has moved Dogecoin and Bitcoin with his tweets. It's pretty crazy that an asset could go up or down in price simply because some billionaire posts a meme, but that's the world we are living in.
When someone you consider an authority makes a remark on a subject, try to evaluate the truth of the statement based on the facts, and not what a so-called expert is spouting. The other big issue is that a lot of these authority figures have a vested interest in what they are discussing. If one of these authority figures owns XYZ, of course, he's going to say positive things as he wants them to go up in price, not down.
Why we follow the words of authority figures is a whole other group of misjudgment including mere association, optimism, consistency, envy, liking, social proof, believe first and doubt later, emotions, and probably a bunch of others.
Sensemaking
We humans have to make sense of our world. We don't like uncertainty. We prefer to twist and warp facts into "rational" thoughts that help us understand the world, even when we twist them beyond recognition. We fear the unknown and dislike unpredictability.
I think this is why people love to associate the macro with the micro. For instance, we might have a great investment, but it's going down in price. We make sense of this by saying that the economy has slowed down, due to higher interest rates, and that experts see these rates increasing for the next 4 quarters. In reality, there are 1000 variables as to why your stock is going down, and trying to make sense of each and every one of them is a lesson in futility.
Somethings are too difficult to try and make sense of. You're better off reducing your risk to these events. Charlie Munger said: "around here I would say that if our predictions have been a little than other people's, it's because we've tried to make fewer of them." Unfortunately, we cannot make sense of everything in our world. Once you realize this you open yourself up to the powers of chance.
There are many other misjudgments I didn't cover, and I'll try and get to those in future writings.
For more info check our Charlie's video of human misjudgment:
Other great sources are Poor Charlie'd Almanack and Seeking Wisdom.