Bubble

Reviewed by Apoorva | Updated on Sep 28, 2020

Introduction

A bubble is an economic cycle defined by the rapid escalation of asset prices that occurs after a contraction. It is created by a swell in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behaviour.

Understanding Bubble

Upon asset prices reaching the peak, investors may not be willing to buy; a massive sell-off occurs leading the bubble to deflate. Bubbles are formed due to a change in investor behaviour regarding economies, securities, stock markets, and business.

Steps Involved in a Bubble

  1. Displacement: Occurs when investors start to notice a new paradigm, such as historically low-interest rates.

  2. Boom: Prices start to rise, leading to more investors entering the market.

  3. Euphoria: When euphoria hits, and asset prices skyrocket, caution is given.

  4. Profit-taking: It is not easy to predict when a bubble will burst. People who understand the warning signs will make money by selling off positions.

  5. Panic: Asset prices drop as quickly as it rose. Investors would want to liquidate them at any price even when asset prices decline as supply outgrows demand.

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