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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?)

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    "The market can remain irrational longer than you can remain solvent." In other words, (to paraphrase Christian Bale's boss in The Big Short) being right at the wrong time is the same as being wrong. Be particularly careful about investing with debt ('leveraging'), as this can magnify the impact of being 'too early' in your decisions (ie: being wrong).
    – Grade 'Eh' Bacon
    Commented Feb 21, 2018 at 2:56
  • @Grade'Eh'Bacon Yes, to clarify, I'm not even considering going into debt to invest (or margin calling or short-selling or the like), and all told, I have a (small) positive net worth, which includes some of these irrationally valued assets, and am unsure on what the proper general approach to them is. (And for that matter, it seems to me that even "safe" investments like, say an indexed Dow or S&P500 fund are irrationally over-valued at the moment, so I'm not even talking strictly about bubbles, but that irrationally value dynamic in general.)
    – HopelessN00b
    Commented Feb 21, 2018 at 3:00
  • If those are a good fit for your investment strategy is for you to decide. If I may offer this poker analogy, winning the pot does not mean you made the right calls. It just means you won. Conversely, losing the pot does not mean you made the wrong calls. Here, you're looking at the results of Bitcoin's growth and thinking it would have been a good decision to invest in it.
    – ApplePie
    Commented Feb 21, 2018 at 3:07
  • @ApplePie As it so happens, I am a profitable poker player, so I’m well acquainted with the concepts of “pot odds” and “results oriented play”. :) That’s more along the lines of what I’m looking for here. General strategies or concepts for this investing situation, rather than what pot odds I need to call a river bet, or when to draw to a flush, in poker terms.
    – HopelessN00b
    Commented Feb 21, 2018 at 3:11
  • Isn't what seems as a market behaving irrationally just a lack of information on your side? Keep in mind, that nothing is priced at it's "real" value, just at the percieved value attributed by the market actors. Nothing has any minimal intrinsic value. More food as anyone can eat is as useless as is a heap of gold, when noone has any food to sell for it.
    – I'm with Monica
    Commented Feb 21, 2018 at 11:45

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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.

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  • That's rather helpful (short term investing or long term investing), thanks.
    – HopelessN00b
    Commented Feb 21, 2018 at 14:51

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