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How Can We Take Advantage of The Market’s Mistakes?

Back in October 2013, the stunning collapse in price of three shares in Singapore had sent a chilling reminder to speculators: Getting caught up in a financial bubble can have disastrous consequences.

The three shares in question are namely Asiasons Capital Limited (SGX: 5ET), Blumont Group Ltd (SGX: A33) and LionGold Corp Ltd (SGX: A78). Prior to their collapse, the trio had climbed sharply in price (to a level that couldn’t be supported by any business fundamentals), only to then fall by more than 40% each in a single day back then. You can read the whole story here. Now, all three shares are still down by more than 90% in price from their peaks prior to the crash.

Interestingly, this isn’t the first time a similar situation has occurred – a penny stock called Uni-Asia Holdings Ltd (SGX: C3T) had also gone through that boom-and-bust cycle back in 2007. But, the speculators with Asiasons, Blumont, and LionGold did not seem to have learnt any lessons from the Uni-Asia debacle.

As people, we grow up understanding the concept of “learning from our mistakes.” But, it seems the market never learns. Why is that the case?

Thing is, that’s not a question we have to answer. What we need to know is that it can be very advantageous for investors to have the market be prone to repeat its mistakes all the time. By understanding how market bubbles develop, we can position ourselves to profit from the market’s overreactions. I’ve discussed the life cycles of a financial bubble previously – you can read all about it here.

The important thing to note that is that market psychology often overshoots to the extreme when it comes to euphoria and despair. As investors, we can do well in investing if we’re able to see when the market is overly-euphoric and when is the market overly-depressed. If we’re able to spot a company which has collapsed in price dramatically predominantly due to a change in market-perception (this means to say that the company’s business fundamentals are intact), it might turn out to be a very good opportunity for us.

Companies such as Courts Asia Ltd (SGX: RE2), Neptune Orient Lines Ltd. (SGX: N03), Genting Singapore PLC (SGX: G13), and Super Group Ltd. (SGX: S10) have all declined significantly in price in 2014 so far. Our job as investors is to figure out which are the great companies that might return to their former glories and which are facing fundamental challenges that may very likely lead to a permanent decline in their business prospects.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns shares in Genting Singapore and Super Group