The Psychology of Bubbles: Why Investors Keep Falling for the Same Old Cons

In case you missed it, Bitcoin has been having an awful run over the last few months.

This past weekend, Bitcoin’s price fell below $80,000 for the first time since April 2025, when global markets reacted to tariff announcements. The sell-off came as the market reacted to the hawkish pick of Kevin Warsh as the incoming Federal Reserve chair. And analysts have warned that it’s not likely to recover anytime soon.

January marked the fourth straight month of decline, and as of today, its price is hovering just above $70,000. It’s a staggering shift from its peak last year, when a pro-crypto White House and growing institutional interest drove the price above $126,000.

Our view? The volatile price of crypto is something we’ve been warning our readers about since 2017. See Buying Cryptocurrency: Fad, Fraud or Fortune-Maker?, Cryptocurrency Investing: Asset or Instrument of Speculation?, and Speculation Nation: Who Ya Gonna Call — Your Broker Or Your Bookie?.

Bitcoin’s journey since 2017, even with its recent reversal, could be pointed to support the argument that we were dead wrong. We nonetheless stand by what we said: buying Bitcoin in the hope that it will rise in value is not investing. It is speculation. If you want to speculate, go ahead. But do not confuse the two activities. Who knows, speculators often turn out to be right. That said, we continue to think it is a bubble, albeit a prolonged one.

Bubbles are far from rare events in financial history. Every few years, a new, shiny asset captures investors’ interest, prices surge beyond what fundamentals can justify, and the cycle repeats.

What is a bubble?

Robert Shiller, the Nobel Prize-winning economist who has written extensively on bubbles, defines a speculative bubble as:

“A situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”

Underpinning this is the fact that bubbles are often driven by psychology. A bubble forms when prices become unsustainably disconnected from underlying fundamentals, driven by narrative momentum and investor psychology rather than economic reality.

‘Bubble’ has been used to describe a number of events, from the Tulip Mania that seized the Netherlands in the 17^th century, to the dot-com crash, to Miami real estate. More recently, interest has heightened around the possibility of an AI bubble (our thoughts on that here).

According to Shiller, “we’re always in a bubble somewhere.”

This all makes sense, but in practice, it’s extremely challenging to identify and act on a bubble when it unfolds.

Certain sectors, such as AI or tech, may resemble a bubble with their sky-high valuations, but those valuations may be justified by real improvements in technology and growth in revenue. Time will tell whether this is ultimately the case.

Moreover, a market crash is sometimes diagnosed as a bubble bursting, but the market may simply be correcting itself when an asset becomes overvalued. Some experts have flagged that this is normal market behavior rather than a bubble bursting.

So, bubbles can be extremely hard to spot. Yet, the behavior that fuels them is surprisingly consistent, which raises the obvious question…

Why do investors keep falling for the same speculative patterns?

It’s tempting to assume bubbles are driven by irrational actors or inexperienced speculators. In reality, they often involve sophisticated participants who fall victim to the same psychological pressures we’re all prone to, and to a smaller group of very experienced speculators who know exactly what they are doing and who successfully get out before the music stops (sorry/not sorry for mixing metaphors).

Fear of Missing Out (aka FOMO)

FOMO is arguably the “defining feature of all the major asset bubbles of the last 400 years,” according to Ross Mayfield at Baird Wealth.

When the price of a certain asset starts to soar, investors will often get excited, abandoning their own plans and rushing to join the momentum.

This is a natural market response, but what turns a bull market into a bubble is when investors, driven by too much FOMO, start to push prices past a rational level.

Want an example of the type of stories that drive FOMO? Check out this 2018 New York Times article on the insane boom of crypto, which has FOMO in its very title: Everyone Is Getting Hilariously Rich and You’re Not.

Collective excitement, amplified by media hype, can skew the good judgment of thoughtful investors, pushing them to investments that don’t align with their goals or investing strategy.

It’s why the highly respected financial writer Morgan Housel has advised that overriding FOMO may just be the biggest factor in improving your financial situation.

“I’ll get out in time.”

Those are the famous last words of many investors who get into bubbles, thinking they can time their exit just before the bubble pops.

This is the comforting fantasy that bubbles are dangerous, yes, but only for other people. Surely, we will be the clever ones who sell at the top, just before the music stops.

Mark Hulbert at MarketWatch explains that bubbles often involve cognitive dissonance: investors may recognize that prices are overvalued, but keep buying anyway, thinking they’ll spot the turning point in time. We saw this in August 2025 when a Bank of America survey found that a record 91% of fund managers surveyed believed the market was overvalued, yet bullish sentiment continued to grow.

This thinking is otherwise known as the Greater Fool Theory: the assumption that there will always be someone else willing to pay more, right up until the very last second (not to be confused with those who actually get out and who, as noted above, take advantage of the Greater Fool Theory).

The problem with this thinking is that, unfortunately, bubbles have a habit of bursting faster than anyone expects — usually right after the crowd agrees they still have plenty of time.

“This Time It’s Different”

At the heart of every speculative bubble, investors will often try to convince themselves that old rules no longer apply.

According to Howard Marks at Oaktree Capital, bubbles are often formed around a new and exciting development that encourages investors to imagine limitless upside, untethered from historical experience.

When something feels novel or transformative, it’s easier to believe that traditional measures of value are outdated, and that caution is simply a failure of imagination. A new technology has no history to limit our imagination, and its future can thus appear limitless, justifying valuations that go beyond historical norms.

This was the case with crypto, which began in 2008 with a whitepaper proposing Bitcoin’s bold vision of a new financial system that could decentralize banks, published by Bitcoin’s unidentified developer Satoshi Nakamoto.

Up against such ambitions, investor skepticism can feel old-fashioned. Before long, investors are buying into the hype, and the lessons from previous bubbles are long forgotten.

The Bubbles Are Going to Pop Faster Now

Bubbles are ultimately the consequence of our optimism, our envy, and our hubris.

But while the psychology of bubbles hasn’t changed, the speed of them just might.

In recent years, AI has transformed stock trading, with algorithmic trades now dominating market activity. This has made markets more efficient but also amplified their volatility and risks.

Where does this leave us? Market bubbles are ultimately psychological, but today’s AI-driven markets may just make them inflate and burst even faster.

And that, dear readers, is why it’s more important than ever to be aware of the psychologies underpinning your investing decisions, before a new shiny asset captures your attention.

©2026. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.

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