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In general terms, what's the proper response for an investor who owns an investment that is behaving fundamentally irrationally?

I'm thinking of things that are widely regarded as bubbles (Bitcoins, Tesla, and so on), but that's mostly because I can't come up with any examples off the top of my head of any investment that's widely regarded as fundamentally undervalued. Perhaps a financial panic would be the flip side of a bubble.

It seems like the simple answer (sell the bubble, invest more in the irrationally undervalued investment) would be the right one, but then I think of the "Bitcoin bubble" years back when they were worth almost $100 each, or the Tesla bubble a few years back back when it also worth a fraction of its present value... and undoubtedly, there are examples of irrationally undervalued investments that ended up going to 0, which makes me wonder if maybe the better answer is riding along with the irrationality. The market can stay irrational longer than you can stay solvent, after all.

I can see three basic strategies - rationality (sell the bubble, buy the panic), avoidance (staying away altogether) and embracing the irrationality (buying into the bubble/selling the panic with everyone else), but I think I must be missing something, based on what the majority of investors do in these environments.

So, what's the proper strategy to market irrationality? (Or is there a proper strategy, even?)

Bob Baerker
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HopelessN00b
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1 Answers1

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A long term investor should avoid irrational securities such as Bitcoin and its related stocks other than possibly a small amount of lottery ticket gambling money that you are willing to lose on a long shot horse. Volatility is not your friend.

A short term investor or trader looks for the trend and tries to catch some of the ride while practicing disciplined risk management. Determining whether an investment is rational is unimportant. It's not your job or within your ability to figure out why something is moving the way it is and when that move will end (bubble or panic selling). You're opinion of that is irrelevant. Your only objective is to be on the right side of the trade. As an example, many were saying that the DJIA was fundamentally overvalued and behaving irrationally 4, 5, 6+ thousand points ago. How'd that work out?

Use of margin or short selling is for those who know when to apply them as well as how to manage them. The market will quickly separate you from your money if you become the deer in the headlights when it hits the fan.

In some situations, options can help to mitigate some of the risk.

Bob Baerker
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