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Have you been paying attention to the financial media? You cannot escape their warning of an AI bubble. But is there one? And if so, how should we react as traders?

If we look at the bubble talk from a trading (not economic) perspective, I don’t understand what the fuss is about. Traders and investors are making money. And that’s what happens in a bubble!

There is no question that the stock market is higher for a third straight year, and that smacks of over-priced issues. Chip manufacturers like Nvidia NVDA and Broadcom AVGO and cloud computing services from Microsoft MSFT and Amazon AMZN are having banner years. In fact, six of the seven “Mag 7 Stocks” are in the AI space.

What to if there is an AI bubble

From where I sit, it appears the most frenzied AI bubble talk is being fueled by those who are not participating. They are outside of the bubble, watching others make money.

Now, don’t get me wrong – a bubble is not a healthy economic condition. When it bursts, the ripple effects spread quickly across sectors and the resulting damage can take years to repair.

The arguments on both sides – those who believe we are in a bubble and those who do not – make valid points. But they are speculating.

In the meantime, investors and traders are making money hand over fist. And for now, it’s OK to ignore the bubble talk, simply because it’s not productive.

But if we are in an AI bubble and it bursts, I want you to be ready.

Watch the technicals for a change in trend

Four indicators can help you spot a change in the bullish trend:

1. The MACD identifies price trends and measures that trend’s momentum.
2. Moving averages calculate the average price of a stock over a certain time period. If the moving average begins declining, it’s headed into a downtrend.
3. New highs/new lows tells you whether individual stocks are going up or down. When new highs start to fall and new lows begin to climb, the trend is turning bearish.
4. The bullish percent indicator tells you how many stocks have a buy signal. When this crosses below, 50 it could be considered a bearish signal.

(You should also be following these other stock technical indicators.)

Manage your risk properly

This is not the time to get greedy! The swing trading portfolio here at Explosive Options is up 51% on the year. If yours is up nicely for the year, you want to protect those gains – just like I am.

This means I am following a three-fold strategy:

1. I am trading less than 3% of my portfolio right now (never trade more than that!).
2. I am taking smaller positions in any given stock.
3. I am hitting the sell button as soon as I have a profit.

Hold cash

Holding cash is a top risk management strategy, but I wanted to call it out separately here. When the trend turns bearish – whether it’s a short-term correction or the end of a stock bubble – you want to have cash available so you can pick up bargains at an ideal entry point.

A lot of traders and investors did this when stocks plunged 12% a single day at the onset of the COVID-19 pandemic. They scooped up some marquis names and watched their portfolios grow quickly when the markets recovered.

Keep index puts in your portfolio

Index puts act as insurance for your portfolio by lowering your volatility profile. As annoying it is to spend money on insurance that you may or may not need, you will be happy if market volatility kicks higher and/or stocks start to fall. Your portfolio will still lose money, but it won’t be as dramatic.

Be ready to sell quickly

Keep one hand on the exit door. When the AI bubble ends, people will freeze – and then rush for the exit at the same time. As soon as you see bearish signals lining up, sell.

Will that mean you take smaller profits? Some losses? That’s fine. Your portfolio will thank you for saving it.

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