Academy of Financial Trading: The NASDAQ - Recognising a Bubble

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Mar 10, 2015, 05:00 ET

DUBLIN, March 10, 2015 /PRNewswire/ --

Headquartered in Dublin, Ireland, the Academy of Financial Trading is the world leader in financial trading education. With a commitment to excellence in both the provision of education and in the accompanying support throughout, the constant enhancement of the learning experience is paramount to the company. Cutting edge education is provided online - in a highly flexible and accessible nature.

Academy of Financial Trading logo (PRNewsFoto/Academy of Financial Trading)

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A unique insight is offered by the Academy of Financial Trading as to why financial traders all too often lose, and how by working together with their clients, they can help overcome this. The correct management of risk is one of the hugely important subjects covered by the company. It is the ability to protect that which you have worked hard to accumulate - your trading capital - which leads to eventual success.

One of the more popular items covered by the financial media over the past few days was regarding the NASDAQ, and the fact that it is once again reaching upwards towards its record highs, over 5,000 points. This means that it is currently trading at levels not seen since the height of the "Dot-com Bubble", way back in 2000. This raises a valid question - are we now in the midst of another bubble, or this time is it a more sustainable movement? Does the fact that the NASDAQ is now trading at the 5,000 level provide us with a true and fair value as a composite of the stocks within?

Let's start by looking at some hard numbers. In 2000, the price to earnings (P/E) ratio of the companies listed within the NASDAQ was 194. That is a phenomenal and massively overvalued figure. Today, the P/E ratio is a much more sensible figure of 20. In 2000, Apple made up a grand total of 0.5% of the entire index - today it represents 12%. In 2000, there was no Google, no Facebook, no Netflix, no Tesla and no LinkedIn. That might be difficult to imagine today. The largest companies listed at the time were Microsoft, Sun MicroSystems, Oracle, Dell and Cisco, amongst others.

Another, perhaps more confident, figure to note is that cash reserves of more than $360B are held by just 4 companies listed on the NASDAQ - Apple, Microsoft, Cisco and Google. This accounts for almost 25% of the total US corporate cash reserves.

Back in 2000, analyst after analyst was asked their opinion of the markets. Hindsight is a luxury which we can now afford but, at the time, very few were brave (or sensible!) enough to say that there was indeed a danger of some companies being over-valued. This was because of the incessant clambering of traders to get any exposure to what was perceived to be a never-ending rally. This almost became a self-fulfilling prophecy because as the market continued to rise, yet more capital flooded in, causing it to rise further again, causing even more excitement that the market was still rising, causing more capital to flood in.

There is an inherent difficulty in recognising a bubble… the natural exuberance and optimism exhibited by traders and investors on the way up, often tends to lead to a situation where there is absolute faith in the believed strength of the underlying markets. This "blinkered" approach is what eventually leads to a bubble popping, and it exacerbates the subsequent, unavoidable sell-off.

When the NASDAQ reached 5,000 back in 2000, it did not take long before it all came to an end, and the shaky foundations, upon which the rise was based, crumbled - causing it to crash spectacularly.

Unfortunately, like all market tops, or market bottoms, they are not recognised until after the fact. You cannot ever say that a market has "topped", until it starts to fall and does not reach any new higher point. Likewise, you can never say that a market has "bottomed", until it starts to rise and it does not reach any new lower points. This shows the importance of a proven trading strategy, coupled with the correct risk management techniques.

At the Academy of Financial Trading, our Online Trading Course shows potential traders that losses are a natural part of trading. It is how we react when these losses occur which determines our overall success. Will the NASDAQ continue to 5,500, and 6,000, and beyond? We don't know, and we don't believe that any other analyst can ever say for certain. The only one who knows is the market itself. Any market will continue to rise until people stop buying it. A market will no longer rise once all participants who are willing to buy, have indeed bought.

When looking to enter any market - whether it is a potential buy order, or a potential sell order - the first thought in each and every instance should be to accept that risk exists. The next action should be to ensure that you have a pre-defined and acceptable exit strategy in place, in case the market moves against you. This is correct risk management. This will allow you to participate in any market which is forming a bubble, and will also allow you to exit if the bubble does indeed "pop"!

Academy of Financial Trading

http://www.academyft.com

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