Quick definition A bubble is a period when asset prices exceed fundamental value due to speculation and herding. Bubbles eventually burst, causing sharp declines. What it is Bubbles are characterised by: - Rapid price increases (often 100+ percent over months) - Extreme trading volumes - Media hype and retail participation - Disconnection from fundamentals - Eventual sudden collapse Famous bubbles include the dot-com bubble (2000), housing bubble (2008), and crypto bubble (2017-2021). Causes Bubbles are caused by: - Low interest rates (money seeking returns) - Positive feedback loops (rising prices encourage buying) - Herding and FOMO (fear of missing out) - Cognitive biases (overconfidence, recency bias) - Leverage (borrowed money amplifies moves) Signs of a bubble Traders recognise bubbles by: - Valuations far above historical averages - New investors entering who don't understand the asset - Media frenzy and celebrity endorsements - Moral arguments ("this time is different") - Leverage and margin debt rising Bursting Bubbles burst when: - New investors run out (everyone who wanted to buy has bought) - Leverage forces selling (margin calls) - Bad news arrives (removing rose-tinted glasses) - A catalyst triggers panic selling Crashes following bubbles are often sharp (20-50 percent declines in days or weeks). Practical example A new technology stock shows promise. Early investors profit. Media hype spreads. Retail investors pile in without understanding. Prices rise 500 percent in a year. Valuations are absurd (10,000x sales). The stock corrects 80 percent in weeks as bubbles burst. See also - Herding - Irrational Exuberance - Crash - Speculation
