The Role of Investor Sentiment in the Dot-Com Bubble

In the current financial landscape, echoes of past bubbles, such as the Dot-Com Era, reverberate through markets, prompting financial analysts to analyse present conditions with a critical eye. Today's market exuberance shares striking similarities with historical bubbles, particularly in the realm of technology stocks and elevated valuations. By looking into academic research, we can uncover profound insights, unavailable to those investing in the stock market during many historical bubbles, that shed light on the dynamics of today's exuberant markets. Figure 1: An Article from The Guardian in December 2000 Source: The Guardian The Dot-Com Bubble serves as a poignant reminder of the pitfalls of speculative fervour. Much like that era, today's markets are filled with optimism , fuelled by the c ontinued proliferation of technology stocks as the industry continues to ever-evolve. (Figure 2) However, beneath the top layer of soaring valuations lies the potential for irrati...

Figure 1: An illustration of how Behavioural Biases can lead to irrational investing Source: MarketXLS The Dot-com Era stands as a testament to the tie between human psychology and financial markets, where behavioural biases propelled speculative trading to unprecedented heights before the bubble burst. If we go deeper into these biases and their underlying causes we can get invaluable insights into the dynamics of market bubbles. Overconfidence Bias: Overconfidence bias, deeply rooted in human nature, led investors to show an exaggerated belief in their ability to predict the future trajectory of technology stocks . The rapid advancement of the internet and the perceived paradigm shift in business models fuelled this overconfidence, blinding investors to the inherent risks. They erroneously assumed that their knowledge of technology represented an edge in navigating the market, which therefore fuelled speculative trading activities and inflated stock prices beyond rational levels. He...

The impact of investor sentiment on dot-com stock prices during the late 1990s and early 2000s was profound and multifaceted. Investor sentiment, characterized by exuberance and irrational optimism, played a pivotal role in driving dot-com stock prices to unsustainable levels. This sentiment was fuelled by various factors , including technological innovation, fear of missing out (FOMO), speculative trading, overvaluation, and media hype; all of which led to overconfidence with investors (see Figure 1). Figure 1: A visual representation on how FOMO led to overconfidence as seen during the Dot-Com Bubble Source: FasterCapital The rapid growth and potential of the internet as a transformative technology led investors to believe that dot-com companies represented the future of business and commerce. This optimism was further exacerbated by a fear of missing out on potential gains, resulting in a herd mentality among investors who rushed to invest in dot-com stocks regardless of their ...