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Posted February 17, 2021

Ray Blanco

By Ray Blanco

How to Get Rich in a Bubble

As stocks scrape up against all-time highs this month, bubble talk is running rampant…

GameStop. Bitcoin. EVs. Stocks in general. You name it and someone’s calling a bubble right now.

Problem is, folks forget that there’s actually money to be made in a bubble environment if you trade according to a simple plan. To see how, we need to go back to the 1700s.

You’ve probably heard of Sir Isaac Newton.

He was a mathematician, physicist and philosopher whose work was so impactful that he’s still a household name 300 years after his death. But did you know he was also an investor?

He just wasn’t a very good one…

Newton ended up losing much of his fortune in the GameStop of his day: the South Sea Bubble.

Back in the early 1700s, the South Sea Co. had a monopoly on trade with the Spanish colonies in South America, a concession they'd earned by basically assuming the British government's debt from the War of Spanish Succession. To raise money, they turned to the stock market, where they issued stock to investors eager to share in the riches from the South Seas.

The only problem was that the riches weren't quite as vast as the South Sea Co.'s marketing made it seem. Shares exploded higher in the winter of 1720, only to collapse by that fall.

And Isaac Newton got caught in the sell-off after finally deciding to take a big position near the top. While he'd taken some tidy profits that spring on an earlier position, the money being made by Newton's friends and family was too hard to watch. By the time he got back in, it was too late.

This chart of Newton's poor trade timing has become a storied piece of investing lore:

And modern investing publications frequently use it to show the dangers of bubbles.

The problem is that Newton's South Sea chart isn't a cautionary tale for the reasons that most people think. In fact, it shows a big missed opportunity on a huge trend.

Newton's mistake wasn't that he bought into the bubble. His mistake was that he invested using emotion.

Looking at the South Sea chart, Newton really didn't buy at the top. The South Sea Co. continued to rally for months after his "ill-timed" second buy. And it could have actually been a profitable investment had he followed the price action and sold when South Sea rolled over.

Let's imagine for a second that Isaac Newton was actually a rudimentary trend follower. Here's the chart they don't show you -- what the South Sea Co.'s stock price chart looks like with a very simple trend indicator, the 50-day moving average, overlaid on top of it:

Simply by selling all of his South Sea Co. stock when the uptrend broke — by the price sliding below the 50-day moving average — Newton could have walked away incredibly wealthy from one of the most famous boom-and-bust bubbles in history.

Of course, he didn’t.

But it’s hard to blame Newton. It’s human nature to buy high and sell low — we’re practically programmed to do it.

(And if a genius like Newton can fall victim to bubble psychology, we all can.)

But as bubble talk continues to, well, bubble in 2021, Isaac Newton’s wild ride provides an important lesson for investors. First, bubbles aren’t inherently bad. In fact, you can get rich investing in a bubble, as long as you have a systematic plan to get out when the bubble begins to deflate.

We’ll help you navigate things in these pages.


Jonas Elmerraji, CMT

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