Price Bubbles Always Burst: Downside Losses Cancel Upside Gains

Not surprisingly, it's easy to make money on a price upside, particularly when the upside is a price bubble. But when the bubble bursts, declining prices cause most downside buy and sell combinations (trades) to become unprofitable. The net result is that during the life of the bubble losses cancel gains, so the average return is around zero.

The chart of closing daily prices for homebuilder Pacific Standard (SPF) shows the bubble that occurred from March 3, 2003 through April 15, 2008. The somewhat symmetrical price upside and downside are topped by the July 28, 2005 bubble peak at $48.53.

The analysis of the bubble price series shows 831,405 possible buy and sell combinations based on daily closes. For all trades, 44.91 percent were profitable and the average return was -2.60 percent.

For the 184,528 buy on the upside and sell on the upside trade type, 90.42 percent were profitable with a 49 percent average gain.

Of the 414,656 buy on the upside and sell on the downside buy and sell combinations, 44.55 percent made money and the average return was -2.29 percent.

For the 232,221 buy on the downside and sell on the downside trades, only 9.39 percent made money and the average loss was 44.16 percent.

These data reinforce the intuitive; the upside is where to make money and avoid the price downside unless you are short.

Related Articles:

Price Bubbles Always Burst: Downsides Are Rapid and Unrelenting
Price Bubbles Always Burst: Garmin Bubble - June 2005 to October 2007

Posted April 17, 2008.

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